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Rule2023-14925

Determination of Royalty Rates and Terms for Making and Distributing Phonorecords (Phonorecords III)

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Published

August 10, 2023

Effective

August 10, 2023

Issuing agencies

Library of CongressCopyright Royalty Board

Abstract

The Copyright Royalty Judges announce their final determination after remand of the rates and terms for making and distributing phonorecords for the period beginning January 1, 2018, and ending on December 31, 2022.

Full Text

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<title>Federal Register, Volume 88 Issue 153 (Thursday, August 10, 2023)</title>
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[Federal Register Volume 88, Number 153 (Thursday, August 10, 2023)]
[Rules and Regulations]
[Pages 54406-54486]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-14925]

[[Page 54405]]

Vol. 88

Thursday,

No. 153

August 10, 2023

Part II

Library of Congress

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37 CFR Part 385

Determination of Royalty Rates and Terms for Making and Distributing
Phonorecords (Phonorecords III); Final Rule

Federal Register / Vol. 88 , No. 153 / Thursday, August 10, 2023 /
Rules and Regulations

[[Page 54406]]

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LIBRARY OF CONGRESS

37 CFR Part 385

[Docket No. 16-CRB-0003-PR (2018-2022) (Remand)]

Determination of Royalty Rates and Terms for Making and
Distributing Phonorecords (Phonorecords III)

AGENCY: Copyright Royalty Board, Library of Congress.

ACTION: Final rule and order.

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SUMMARY: The Copyright Royalty Judges announce their final
determination after remand of the rates and terms for making and
distributing phonorecords for the period beginning January 1, 2018, and
ending on December 31, 2022.

DATES:
Effective date: August 10, 2023.
Applicability date: The regulations apply to the license period
beginning January 1, 2018, and ending December 31, 2022.

ADDRESSES: The final determination after remand is posted in eCRB at
<a href="https://app.crb.gov/">https://app.crb.gov/</a>. For access to the docket to read the final
determination after remand and submitted background documents, go to
eCRB and search for docket number 16-CRB-0003-PR (2018-2022) (Remand).

FOR FURTHER INFORMATION CONTACT: Anita Brown, CRB Program Assistant,
(202) 707-7658, <a href="/cdn-cgi/l/email-protection#ddbeafbf9db1b2bef3bab2ab">[email&#160;protected]</a>.

SUPPLEMENTARY INFORMATION:

Final Determination After Remand

On October 26, 2020, the United States Court of Appeals for the
D.C. Circuit (D.C. Circuit) issued its mandate vacating and remanding
in part the original Determination \1\ issued by the Copyright Royalty
Judges (Judges) in the captioned proceeding. See Johnson v. Copyright
Royalty Board, 969 F.3d 363 (D.C. Cir. 2020). In its ruling on appeal,
the D.C. Circuit found that in the original Determination, the Judges
(1) failed to give adequate notice to participants of their overhaul of
the royalty rate structure combined with significantly increased and
uncapped rates for section 115 licenses; (2) failed to explain why they
rejected a benchmark based on a past settlement agreement \2\ in lieu
of overhauling of the rate structure and significantly increasing
rates; and (3) failed to identify their legal authority to redefine a
material term after they promulgated a definition of that term in the
original Initial Determination circulated to the participants. See
Johnson, 969 F.3d at 367, 381; Initial Determination, Determination of
Royalty Rates and Terms for Making and Distributing Phonorecords
(Phonorecords III), 16-CRB-0003-PR (2018-2022) (Jan. 27, 2018).
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\1\ Determination of Royalty Rates and Terms for Making and
Distributing Phonorecords (Phonorecords III), 84 FR 1918 (Feb. 5,
2019) (final rule and order) (original Determination); see also
Final Determination, 16-CRB-0003-PR (2018-2022) (Nov. 5, 2018). The
original Determination was issued by two of the Judges (Majority)
and was accompanied by a dissenting opinion (Dissent) authored by
the third Judge. The Dissent is appended to and part of the same
document as the original Determination.
\2\ The referenced settlement agreement formed the basis for
regulatory terms relating to section 115 musical works royalties and
was adopted as a final rule in Adjustment [or] Determination of
Compulsory License Rates for Mechanical and Digital Phonorecords,
Docket No. 2011-3 CRB Phonorecords II, 78 FR 67938 (Nov. 13, 2013).
See also Technical Amendment at 78 FR 76987 (Dec. 20, 2013).
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After receipt of the D.C. Circuit's ruling and mandate, the Judges
consulted with the parties to the appeal and established procedures for
the remand proceeding. See Order Adopting Schedule for . . . Remand
(Dec. 23, 2020).\3\ Each side offered opening submissions, responsive
submissions, additional evidentiary filings, and further supplemental
briefing requested by the Judges. The parties' submissions included
legal briefing and incorporated evidence from the original proceeding
as well as evidence newly developed for the remand proceeding. After
preliminary deliberations, the Judges asked for supplemental briefing
from the parties responsive to a proposed alternative rate structure.
See Notice and Sua Sponte Order Directing the Parties to Provide
Additional Materials (Dec. 9, 2021). With respect to redefinition of
the material term Bundled Revenue, the Judges also sought legal
analysis from the parties relating to the D.C. Circuit's directive that
the Judges either provide ``a fuller explanation of the agency's
reasoning at the time . . .'' or take ``new agency action accompanied
by the appropriate procedures.'' See Johnson, 969 F.3d at 392 (citing
Department of Homeland Security v. Regents of the Univ. of Cal., 140 S.
Ct. 1891, 1908). On February 9, 2022, the Judges invited additional
briefing on the Bundled Revenue definition issue, specifically
permitting the parties to offer additional analysis of possible
characterization of the Copyright Owners' motion for clarification
following the Determination as a motion for rehearing under the
Copyright Act, title 17, United States Code at sec. 803(c)(2). See Sua
Sponte Order Regarding Additional Briefing (Feb. 9, 2022).
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\3\ Following the original remand scheduling order, the Judges
amended the remand proceeding schedule by, e.g., permitting
additional briefing, changing due dates, and seeking additional
input with regard to specific issues. See, e.g., Order . . .
Modifying Scheduling Orders (Dec. 13, 2021) (eCRB no. 25973).
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At the request of the parties, the Judges agreed to forego live
testimony. On March 8, 2022, all parties were afforded an opportunity
to present oral argument on all remand issues.\4\ On July 1, 2022, the
Judges issued an Initial Ruling and Order after Remand (Initial Ruling)
\5\--applying Johnson and considering the entire record developed pre-
remand and post-remand.
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\4\ Copyright Owners and Services divided the time for oral
argument. George Johnson dba GEO Music Group waived oral argument.
\5\ The Initial Ruling (eCRB no. 26938) is included in Related
Rulings and Orders as section A. The findings and conclusions in the
Initial Ruling were adopted by a majority of the Judges, but two
Judges filed separate opinions. See Initial Ruling at 2 n.5. One
Judge, former Chief Judge Suzanne Barnett, dissented from the
Majority's conclusion in the Initial Ruling regarding the
Phonorecords II rate structure (section II of the Initial Ruling),
though not from the exception to that benchmark with regard to the
headline rate of 15.1% and the imposition of a cap on the TCC rate
prong. See Dissent in Part re Benchmark (July 1, 2022) (eCRB no.
26943). The other opinion was issued by Judge Strickler, who
dissented from the reasoning relating to the adoption of the
definition of Service Revenue (section V), but concurred in the
adoption of that definition. See Dissent in Part as to Section IV of
the Initial Ruling and Order after Remand . . . (July 1, 2022) (eCRB
no. 26965).
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In the Initial Ruling, the Judges directed the parties to attempt
to submit jointly agreed-upon regulatory provisions implementing the
Initial Ruling for the Judges to consider. The Judges further ruled
that, if the parties could not agree on all the regulatory language,
they should make separate submissions regarding regulatory provisions
in dispute. See Initial Ruling at 114.
The parties agreed to many regulatory provisions but disagreed as
to several such provisions. Accordingly, they filed separate
submissions and respective replies regarding the regulatory provisions.
Services' Joint Submission of Regulatory Provisions (July 18, 2022);
Copyright Owners' Submission of Regulatory Provisions to Implement the
Initial Ruling (July 18, 2022); Services' Joint Response to Copyright
Owners' Submission of Regulatory Provisions (Aug. 5, 2022); Copyright
Owners' Response to Judges' July 27, 2022 Order Soliciting Responses
Regarding Regulatory Provisions (Aug. 5, 2022).
The Judges considered those submissions and entered an order
addressing the disputed regulatory provisions. See Corrected Order
regarding Regulatory Provisions

[[Page 54407]]

Following Initial Ruling and Order (after Remand) (Nov. 10, 2022)
(November 10th Order).\6\
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\6\ The November 10th Order corrected an otherwise substantively
identical order issued two days earlier, on November 8, 2022, which
had inadvertently included a small amount of text. See November 10th
Order at 1 (eCRB no. 27312).
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On November 30, 2022, the parties filed a Joint Submission in which
they provided joint regulatory language no longer in dispute that
applied the binding rulings of the Judges and the D.C. Circuit.\7\
However, the parties identified the single issue in dispute that
relates to the ``Total Content Cost'' (``TCC'') rates for nine
offerings made by interactive streaming services. Joint Submission . .
. Regarding Regulatory Provisions Following Initial Ruling and Order
(after Remand) (Nov. 30, 2022) (Joint Submission) (eCRB no. 27337).
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\7\ The Judges largely adopt the regulations in the Joint
Submission, which reflect the substance of the Judges' post-remand
rulings, the substance and formatting that the Judges had adopted in
the pre-remand Final Determination that were not raised as issues on
appeal, and updates to references to subparagraphs of Section 115 to
conform to statutory amendments made pursuant to the Music
Modernization Act in 2018. Any differences in language or style are
made for ease of reference, consistent with the parties' post-remand
joint filings.
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Having considered the parties' submissions (including the Joint
Submission), the Initial Ruling, and all other pertinent material, the
Judges adopted the several TCC rates set forth in the Phonorecords II-
based benchmark as proposed by the Services. See Order 43 on
Phonorecords III Regulatory Provisions (eCRB no. 28210).\8\
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\8\ The Judges also found good cause to adopt a joint proposal
for modified language regarding late fees, in 37 CFR 385.3. Order 43
on Phonorecords III Regulatory Provisions at 9.
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Based on the entirety of the record, the Judges adopt in toto \9\
the Initial Ruling and the Order 43 on Phonorecords III Regulatory
Provisions which are set out in this document. Accordingly, those two
documents are adopted by reference in this Final Determination After
Remand. Additionally, the regulatory terms that will codify this Final
Determination After Remand are set out in this document.\10\
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\9\ But see Judge Strickler's Dissent, cited at n.5 supra, in
which--although he agrees with the Majority as to the definition of
a Service Revenue Bundle--he disagrees as to the legal reasoning
supporting that conclusion.
\10\ The documents are: Initial Ruling and Order After Remand,
designated as Related Rulings and Orders, section A; Order 43 on
Phonorecords III Regulatory Provisions, designated as Related
Rulings and Orders, section B; Dissent in Part as to Section IV of
the Initial Ruling and Order after Remand by Judge David R.
Strickler, designated as Related Rulings and Orders, section C; and
Dissent in Part re Benchmark, designated as Related Rulings and
Orders, section D.
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On the basis of the foregoing, the Judges propound the rates and
terms described in this Final Determination After Remand for the period
January 1, 2018, through December 31, 2022.\11\ No participant having
filed a timely petition for rehearing, the Judges have made no
substantive alterations to the body of the Initial Determination After
Remand. The Register of Copyrights reviewed the Judges' Final
Determination After Remand for legal error in resolving a material
issue of substantive law under title 17, United States Code, and has
closed her review. Non-substantive typos have been corrected and non-
substantive formatting changes have been made to the version reviewed
by the Register in order to accommodate the Federal Register's
formatting standards. The Librarian shall cause the Judges' Final
Determination After Remand, and any correction thereto by the Register,
to be published in the Federal Register no later than the conclusion of
the Register's 60-day review period.
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\11\ The regulations applicable to the period 2018 through 2022,
as set forth following this SUPPLEMENTARY INFORMATION section, will
appear in the CFR as appendix A to the current regulations. Although
these Phonorecords III regulations adopt the substance of the
Phonorecords II-based benchmark where the Judges so require, in
Sec. Sec. 385.21 and 385.22, these Phonorecords III regulations are
structured, consistent with the parties' Joint Submission, in the
same consolidated manner as set forth in the pre-remand Phonorecords
III regulations (a structure as to which no party appealed). See
Exhibit A to the Joint Submission at 16, n. 47; see also Exhibit B
to the Joint Submission at n.17 (red-lined version of Exhibit A,
supra).
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Related Rulings and Orders

A. Initial Ruling and Order After Remand (Redacted Version With Federal
Register Naming and Formatting Conventions)

On October 26, 2020, the United States Court of Appeals for the
D.C. Circuit (D.C. Circuit) issued its mandate vacating and remanding
in part the Determination \12\ issued by the Copyright Royalty Judges
(Judges) in the captioned proceeding. See Johnson v. Copyright Royalty
Board, 969 F.3d 363 (D.C. Cir. 2020). In its ruling on appeal, the D.C.
Circuit found that in the Determination, the Judges (1) failed to give
adequate notice to participants of their overhaul of the royalty rate
structure combined with significantly increased and uncapped rates for
section 115 licenses; (2) failed to explain why they rejected a
benchmark based on a past settlement agreement \13\ in lieu of
overhauling of the rate structure and significantly increasing rates;
and (3) failed to identify their legal authority to redefine a material
term after they promulgated a definition of that term in the Initial
Determination circulated to the participants. See Johnson, 969 F.3d at
367, 381; Initial Determination, Determination of Royalty Rates and
Terms for Making and Distributing Phonorecords (Phonorecords III), 16-
CRB-0003-PR (2018-2022) (Jan. 27, 2018).
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\12\ Determination of Royalty Rates and Terms for Making and
Distributing Phonorecords (Phonorecords III), 84 FR 1918 (Copyright
Royalty Board Feb. 5, 2019) (final rule and order)
(``Determination''); See also Final Determination, 16-CRB-0003-PR
(2018-2022) (Nov. 5, 2018) (citations to the Determination and to
the Dissent in this Initial Ruling and Order after Remand (Initial
Ruling) are found in this document). The Determination was issued by
two of the Judges (Majority) and was accompanied by a dissenting
opinion (Dissent) authored by the third Judge. The Dissent is
appended to and part of the same document as the Determination.
\13\ The referenced settlement agreement formed the basis for
regulatory terms relating to section 115 musical works royalties and
was adopted as a final rule in Adjustment of Determination of
Compulsory License Rates for Mechanical and Digital Phonorecords,
Docket No. 2011-3 CRB Phonorecords II, 78 FR 67938 (Nov. 13, 2013),
Technical Amendment at 78 FR 76987 (Dec. 20, 2013). In this Initial
Ruling, references to Phonorecords II, PR II, and PR II-based
benchmark are references to this final rule.
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After receipt of the D.C. Circuit's ruling and mandate, the Judges
consulted with the parties to the appeal and established procedures for
the remand proceeding. See Order Adopting Schedule for . . . Remand
(Dec. 23, 2020).\14\ Each side offered opening submissions, responsive
submissions, additional evidentiary filings and further supplemental
briefing requested by the Judges. The parties' submissions included
legal briefing and incorporated evidence from the original proceeding
as well as evidence newly developed for the remand proceeding. After
preliminary deliberations, the Judges asked for supplemental briefing
from the parties responsive to a proposed alternative rate structure.
See Notice and Sua Sponte Order Directing the Parties to Provide
Additional Materials (Dec. 9 Order). The Judges also sought legal
analysis from the parties relating to the D.C. Circuit's directive that
the Judges either provide ``a fuller explanation of the agency's
reasoning at the time . . .'' or take ``new agency action accompanied
by the appropriate procedures.'' See Johnson, 969 F.3d at 392 (citing
Dep't of Homeland Sec. v. Regents of the Univ. of Cal., 140 S. Ct.
1891, 1908 (Regents)). On February 9, the Judges invited additional
briefing on

[[Page 54408]]

the service bundle definition issue, specifically permitting the
parties to offer additional analysis of possible characterization of
the Copyright Owners' motion for clarification following the
Determination as a motion for rehearing under the Copyright Act, title
17, United States Code (Act) at sec. 803(c)(2).
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\14\ Following the original remand scheduling order, at the
request of parties or on their own motion, the Judges amended the
remand proceeding schedule by, e.g., permitting additional briefing,
changing due dates, and seeking additional input with regard to
specific issues. See, e.g., Order . . . Modifying Scheduling Orders
(Dec. 13, 2021).
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At the request of the parties, the Judges agreed to forego live
testimony. On March 8, 2022, all parties were afforded an opportunity
to present oral argument on all remand issues.\15\ Following oral
argument, the Judges deliberated and now issue this Initial Ruling
after Remand.
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\15\ Copyright Owners and Services divided the time for oral
argument. George Johnson dba GEO Music Group waived oral argument.
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After due consideration of all of the evidence and oral argument of
counsel, the Judges \16\ determine: \17\
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\16\ The findings and conclusions in this Initial Ruling are
adopted by a majority of the Judges. One Judge dissents from the
adoption of the entirety of the Phonorecords II rate structure
(section II), though not from the exception to that benchmark with
regard to the headline rate of 15.1% and the imposition of a cap on
the TCC rate prong. One Judge dissents in part from the reasoning
relating to adoption of the definition of Service Revenue (section
V), but not from the adoption of that definition.
\17\ As addressed infra, the Judges also order that the
participants in this remand proceeding prepare and submit regulatory
provisions consistent with this ruling. See Footnote 174.
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(1) With regard to the applicable rates and rate structure, the
percent-of-revenue all-in headline royalty rate for the mechanical
license shall be set at 15.1%, phased-in, as set forth below:

2018-2022 All-In Headline Royalty Rates
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2018 2019 2020 2021 2022
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Percent of Revenue........................ 11.4% 12.3% 13.3% 14.2% 15.1%
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In all other respects, the rates and rate structure of the
Phonorecords II-based benchmark proposed by the Services (as that
benchmark is defined herein) shall constitute the rates and rate
structure for the Phonorecords III period.\18\
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\18\ The Services include in their Joint Rate Proposal a chart
summarizing the proposed rates for their offerings. That chart is
attached as an Addendum to this Initial Ruling.
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To be clear: the 15.1% headline percentage rate substitutes for the
headline percentage rates in subparts B and C of the Services
Phonorecords II-based benchmark, and the definition of ``Service
Revenue'' for bundles shall be the definition contained in 37 CFR
385.11 (paragraph (5) for the ``Service Revenue'' definition) as
proposed in the Services' Phonorecords II-based benchmark.
(2) The Services' Phonorecords II-based benchmark is the better of
the benchmarks proposed by the parties and satisfies the requirements
of 17 U.S.C. 801(b)(1) in all respects. However, as noted supra, to be
consistent with this statutory section and the decision in Johnson, the
royalty rate of 10.5% in that benchmark shall be replaced with the
15.1% rate set forth in paragraph (1) above.
(3) To reiterate for clarity, consistent with the adoption of the
Phonorecords II-based benchmark, and for the reasons more fully
developed herein, the Judges adopt the definition of ``Service Revenue
for Bundled Services'' as it appeared in the Initial Determination in
the underlying proceeding. Following are the Judges' analysis and
ruling after remand.

I. Preliminary Issue: Burden of Proof

As a preliminary matter, the Judges address the issue of burden of
proof raised by both parties. Pursuant to the Administrative Procedure
Act (APA), ``the proponent of a rule or order has the burden of
proof.'' 5 U.S.C. 556(d). See also Initial Remand Submission of
Copyright Owners at 48 (Apr. 1, 2021) (``CO Initial Submission'')
(citing section 556(d) of the APA as setting forth ``a basic rule of
these rate-setting proceedings that a participant is required to
provide evidence establishing the propriety of all aspects of its own
proposed rates and terms, including all aspects of the participant's
proposed rate structure.''). Accordingly, it is clear to the Judges
that the Services should continue to bear the burden of proof regarding
the sufficiency of their proffered Phonorecords II-based benchmark in
this remand proceeding. And, in like fashion, because on remand
Copyright Owners have assumed the mantle of pursuing the vacated rate
structure and rates, they bear the burden of proof with regard to their
proposal.
However, Copyright Owners assert that it is the Services who bear
the burden of proof as to Copyright Owners' proposal regarding the
appropriateness, vel non, of an uncapped TCC rate prong. According to
Copyright Owners, this burden falls on the Services because ``only the
Services . . . proposed TCC prongs at the hearing,'' in the form of the
mix of capped and uncapped TCC prongs contained in the Services'
Phonorecords II benchmark. Id. at 47. The Judges find that the fact
that the Phonorecords II-based benchmark advanced by the Services
contains this mix of capped and uncapped TCC prongs does not bear on
Copyright Owners' duty, under 5 U.S.C. 556(d), to satisfy the burden of
proof with regard to the rates and rate structure they are advancing on
this remand. Moreover, the D.C. Circuit has already held that the fact
that some of the Streaming Services' proposals contemplated continued
use of an uncapped total content cost prong for some categories ``does
not mean they anticipated that the [Judges] would uncap the total
content cost prong across the board . . . [which] is quite different.''
Johnson, 369 F.3d at 382. The difference, according to Johnson, is that
``[u]ncapping the total content cost prong across all categories leaves
the Streaming Services exposed to potentially large hikes in the
mechanical license royalties they must pay.'' Id.
Accordingly, the Judges find that Copyright Owners indeed do bear
the burden of proof with regard to the appropriateness of uncapped rate
structure and rates they are proposing on remand and the Services bear
the burden of proof with regard to the appropriateness of the
Phonorecords II-based benchmark they are continuing to advance on
remand.

II. Rate Structure and Rates

A. Relevant Rulings in Johnson

In establishing a royalty rate structure and the rates within it in
the context of this remand proceeding, the Judges are guided by the
rulings in Johnson.
1. Percent of Revenue Prong
The D.C. Circuit noted that the Judges found the royalties in the
Phonorecords II period were too low and that record companies were
receiving a disproportionate share of the sum of the mechanical and
sound recording royalties. Johnson, 969 F.3d at 384-85. The D.C.
Circuit acknowledged that ``[t]he Judges . . . then carefully

[[Page 54409]]

analyzed the competing testimony and drew from it rates that were
grounded in the record and supported by reasoned analysis.'' Id. at
385. The D.C. Circuit found that the Judges acted well within their
discretion and not arbitrarily, relying on substantial evidence in
establishing the ``zone of reasonableness'' for the rates. Id. As the
D.C. Circuit noted, the Judges' process was ``the type of line-drawing
and reasoned weighing of the evidence [that] falls squarely within the
[Judges'] wheelhouse as an expert administrative agency.'' Id. at 385-
86 (emphasis added).
2. Uncapped TCC Prong
The D.C. Circuit found fault, however, in the Judges' determination
to establish an uncapped and increased percentage-based total content
cost (TCC).\19\ Id. at 380. This approach ``removed the only structural
limitation on how high the [TCC] . . . can climb.'' Id. The D.C.
Circuit reasoned that uncapping the TCC alternative rate prong across
all categories of service exposed the Services to potentially large
hikes in the overall mechanical royalties they must pay. Id. at 382.
The D.C. Circuit noted: ``As the [Judges] acknowledge, sound recording
rightsholders have considerable market power vis-[agrave]-vis
interactive streaming service providers . . . . The interactive
streaming services are . . . exposed to the labels' market power and
record companies could, if they so chose, put those services out of
business entirely . . . . [B]y virtue of their oligopoly power, the
sound recording copyright holders have extracted `inflated' royalties.
. . .'' Id. (cleaned up).
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\19\ ``TCC'' refers to ``Total Content Cost,'' and is defined as
``a percentage of the royalties paid by the service . . . to sound
recording copyright holders.'' Johnson, 969 F.3d at 370; see also
Determination at 13 n.38 (``TCC'' is an industry acronym for ``Total
Content Cost'', a shorthand reference to the extant regulatory
language describing generally the amount paid by a service to a
record company for the section 114 right to perform digitally a
sound recording.'').
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While the Services had advocated uncapping the TCC alternative rate
prong for some categories of service, that ``does not mean they
anticipated that the [Judges] would uncap the total content cost prong
across the board. That is quite different.'' Id. at 382. The D.C.
Circuit found that the Judges ``failed to provide adequate notice of
the drastically modified rate structure [they] ultimately adopted.''
Id. at 381. The D.C. Circuit emphasized that the failure to provide
adequate notice of their intentions ``is no mere formality [because]
[i]nterested parties' ability to provide evidence and argument . . .
not only protects the parties' interests, it also helps ensure that the
[Judges'] ultimate decision is well-reasoned and grounded in
substantial evidence.'' Id. at 381-82.
To support their adoption of an uncapped TCC rate prong, the Judges
``predicted that the sound recording copyright owners' royalty rates
would naturally decline in the course of their negotiations with
interactive streaming services.'' Id. at 372. The Judges found
persuasive the rebuttal testimony of one of Copyright Owners' economic
expert witnesses, Professor Watt, that an increase in mechanical
royalties payable by the Services would lead to a corresponding
decrease in the Services' sound recording royalty obligations. See
Determination at 73-74 (``[S]ound recording royalty rates in the
unregulated market will decline in response to an increase in the
compulsory license rate for musical works [and] Professor Watt's
bargaining model predicts that the total of musical works and sound
recordings royalties would stay ``almost the same'' in response to an
increase in the statutory royalty.''). The Services painstakingly
criticized this ``see-saw'' theory.
The D.C. Circuit concluded that, on remand, if and when the Judges
consider the ``uncapped'' rate structure, they shall address all
substantive challenges to that approach raised by the Services,
including the issue of whether ``an increase in mechanical license
royalties would lead to a decrease in sound recording royalties.'' Id.
at 383.
Thus, the D.C. Circuit held, the Judges erred procedurally in
adopting an uncapped TCC alternative rate prong. The D. C. Circuit
therefore instructed the Judges to provide the parties with the
opportunity to fully address the issues regarding the uncapped TCC
prong, and for the Judges to address the ``substantive challenges''
raised by the Services.
3. Four Itemized Statutory Objectives
The statutory standard found in section 801(b)(1) instructs the
Judges to set rates that are not only ``reasonable,'' but also
reflective of four itemized objectives, or factors, which, as the D.C.
Circuit stated, set forth ``competing priorities.'' 17 U.S.C.
801(b)(1)(A)-(D); Johnson, 969 F.3d at 387.\20\ With regard to these
four priorities, the D.C. Circuit found that the Judges properly
analyzed and applied the first objective (Factor A). Id. at 387-88. In
particular, the D.C. Circuit did not disturb the Judges' ruling that an
increase in the royalty rates for mechanical licenses was necessary in
order to satisfy Factor A. Johnson, 369 F.3d at 387-88. According to
Johnson, in making this finding, the Judges had engaged in a
``reasonable reading of the record'' and had relied on ``substantial
evidence.'' Id. at 388. Thus, Factor A (when considered without regard
to the other three objectives) indicated that the statutory rate needed
to be higher than it was during the Phonorecords II period.\21\
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\20\ These competing objectives are: (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 economic conditions; (C)
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; and (D) To minimize any disruptive impact on
the structure of the industries involved and on generally prevailing
industry practices. Id.
\21\ However, as the D.C. Circuit also noted, because the four
section 801(b)(1) objectives reflect ``competing priorities, id'' at
387, the holding that Factor A militates toward a higher rate is not
ultumately dispositive. Rather, it must be weighed with the other
statutory factors.
---------------------------------------------------------------------------

With regard to the other three objectives, Johnson stated that
``[t]he question whether the [Judges] adequately addressed factors B
through D . . . is intertwined with the nature of the rate structure
ultimately imposed by the [Judges].'' Id. at 389. Accordingly, the D.C.
Circuit concluded that it ``need not . . . address whether the [Judges]
adequately considered these remaining factors.'' Id.\22\
---------------------------------------------------------------------------

\22\ The phrase ``intertwined with the nature of the rate
structure'' requires emphasis because the Majority independently
considered how to weigh Factors B and C specifically as to the 15.1%
revenue rate, without regard to the overall rate structure, as
discussed infra.
---------------------------------------------------------------------------

Within the parameters of the holdings in Johnson, the Judges
consider the record facts and the arguments made in this remand
proceeding, together with the pertinent facts and arguments made in the
original proceeding.

B. Rate Evidence for the 33-Months From January 2018 Through September
2020

After the Determination was issued, from its effective inception on
January 1, 2018, through September 30, 2020--a 33-month period--the
parties operated under the rates and rate structure set forth in that
ruling. In light of the D.C. Circuit's decision in Johnson, as of
October 1, 2020, the parties reverted to the Phonorecords II rates. The
Services have asserted in this remand proceeding that, during the 33-
month period when the Majority's new and higher

[[Page 54410]]

Phonorecords III rates were in effect, [REDACTED]. By contrast,
Copyright Owners, on remand, looking at the same data over this 33-
month period, aver that they prove the existence of the seesaw theory.
1. Services' Position
According to the Services, [REDACTED]. [REDACTED]. Moreover,
according to the Services, [REDACTED]. The Services further maintain
that, [REDACTED].
The Services make the [REDACTED]. And, [REDACTED]. Id. ]] 5, 9-13,
16-19, 22-23, 26-27.
The Services claim that [REDACTED]. More particularly, [REDACTED].
[REDACTED]. [REDACTED].
The Services' economic experts rushed to judgment upon learning of
these facts, claiming that they disproved the seesaw theory. See Katz
WDRT ]] 25-27 (relying on testimonies cited supra and concluding that
seesaw theory was disproved, based on [REDACTED]); Marx WDRT ]] 48-51
(relying on same testimonies and likewise finding because [REDACTED]);
Leonard WDRT ] 17. ([REDACTED]).
2. Copyright Owners' Position
Copyright Owners analyzed the royalty data over the same 33-month
period (January 2018 through September 2020) and reach the opposite
conclusion. One of their economic expert witnesses, Dr. Jeffrey
Eisenach, testified that [REDACTED]. Moreover, he opined that
[REDACTED]. See Eisenach RWRT sec. 2(A) & appx. C.
Based on this analysis, Professor Watt declares empirical
vindication of his seesaw theory. Watt RWRT ]] 41-42, 46 (``The
[Judges'] bargaining theory insights about the relationship between
royalty rates were correct. . . . [REDACTED]. . . .'').
3. Analysis and Decision Regarding Evidence of Post-Determination Rates
The Judges are perplexed by the willingness of the expert economic
witnesses on both sides to opine that the rate changes from January
2018 through September 2020 can serve as confirmation of their clients'
respective positions. The issue to be considered empirically was
whether the sound recording rate would decrease in response to the
increase in the mechanical rate. That is, if the record labels had
previously set royalties at a level that would allow the Services
merely to survive, would the record labels agree to lower their sound
recording rate if more of the Services' surplus were acquired by
Copyright Owners? To answer this question, the economists on both sides
applied sophisticated bargaining models and critiques to explain the
nature of the negotiations that would ensue.
In the process, the economists lost track of an obvious, elementary
point: The Phonorecords III rates were being challenged by the
Services' appeal, and might not persist. Indeed, the rates were
ultimately vacated and the parties returned in October 2020 to the
Phonorecords II rates.\23\ Now, the rates will be changed again by this
post-remand Determination, and going forward may be subject to further
potential change, consistent with the provisions of title 17. In light
of such ongoing fundamental uncertainty, why would any economist or
businessman assume that the sound recording companies would agree to
adjust their rates in response to a change in the mechanical rate? The
Judges are amazed that the economic experts neglected even to raise
this uncertainty as a complicating issue, let alone a dispositive
one.\24\
---------------------------------------------------------------------------

\23\ There also was uncertainty as to the effective inception
date of the Phonorecords III rate period, because the Services had
appealed (ultimately unsuccessfully) the CRB Judges' finding that
the period commenced, retroactively, as of January 1, 2018.
\24\ To place this point in the economic context of this
proceeding, the Judges characterize the ongoing ``legal
uncertainty'' as another ``independent variable'' to add to the
economic experts' list of such variables, discussed infra, that
affect the ``dependent variable,'' viz., the sound recording rate.
---------------------------------------------------------------------------

Moreover, no party called as a witness any representatives of the
Majors, or subpoenaed their testimony or documents, to provide the
Judges with evidence of how these record companies perceived the seesaw
issue, whether as a permanent phenomenon or as an uncertain matter,
given the pendency of the legal proceedings regarding the ultimate
mechanical rate. Any of the parties could have requested that the
Judges subpoena a sound recording industry witness to give testimony
and produce documents as to this issue, pursuant to 17 U.S.C.
803(b)(6)(C)(ix), but none did so. Further, Copyright Owners, who are
representing the music publishing interests of inter alios, Sony,
Universal, Warner, and Merlin, likely could have produced such sound
recording witnesses without the need for a subpoena. Witnesses from
these entities who negotiated with the Services after the Phonorecords
III rates and rate structure became effective certainly would have
knowledge relevant to the testimony of the Services' witnesses
[REDACTED] who claimed that [REDACTED].
Simply put, the period from period from January 2018 through
September 2020 was a time the Judges construe as ``33-months of
uncertainty,'' see 3/8/22 Tr. 87, 91 (Closing Argument) when no party
could ascertain with any assuredness the ultimate Phonorecords III
rates and rate structure. Thus, for the economists and the parties to
claim vindication for their arguments by reliance on how the record
labels did or did not respond to the challenged and ever-shifting rates
during this ``33 months of uncertainty'' reflects the elevation of
adversarial zeal over objective judgment.
Accordingly, the Judges place no weight on the purported changes or
stability of the sound recording rates during the Phonorecords III rate
period.

C. Percent-of-Revenue Rate Prong

1. Copyright Owners' Position
In their initial remand submission, Copyright Owners provided no
new evidence to support any aspect of the 15.1% revenue-based rate (or
for that matter, any new evidence to support the rates or rate
structure in the Determination), and elected to rely on the pre-remand
record. In fact, in their initial remand submission, Copyright Owners
do not so much as mention the 15.1% revenue rate derived by the Judges.
However, in their reply remand submission (which the Judges found also
to constitute, in part, a substantive initial submission \25\)
Copyright Owners do address the 15.1% revenue rate. In the reply
submission, Copyright Owners simply stated: ``[T]he Circuit affirmed
the Board's derivation of rate percentages, including raising the
revenue rate to 15.1%.'' Copyright Owners' Reply Brief on Remand (in
Reply Remand Submission of Copyright Owners, Vol. 1) at 64, n.48 (July
2, 2021) (``CO Reply''). In a subsequent submission, Copyright Owners
added that ``[t]he narrow mandate on this Remand does not allow for
reopening the rate percentage determination in the [ ]Determination.''
Copyright Owners' Motion for Reconsideration or Clarification at 15 &
n.10 (Dec. 17, 2021) (emphasis added) (Dec. 17th Motion).
---------------------------------------------------------------------------

\25\ See Order Denying in Part and Granting in Part Services'
Motion to Strike Copyright Owners' Expert Testimony and Granting
Services' Request to File Supplemental Testimony and Briefing at 11
(Oct. 1, 2021) (Oct. 1st Order) (The Judges found that ''with one
exception . . . the challenged testimonial evidence of Copyright
Owners' economic expert witnesses serve the dual purposes of direct
and rebuttal statements'' and, as a consequence, ``provide[d] the
Services an opportunity to file supplemental testimony and briefing
in opposition.
---------------------------------------------------------------------------

Thereafter, Copyright Owners asserted that the D.C. Circuit's
affirmance of the

[[Page 54411]]

[Judges'] revenue percentage rate calculation was ``strong[ ]'' and
``detailed.'' Copyright Owners' Reply in Further Support of Motion for
Reconsideration or Clarification at 4 (January 5, 2022). Moreover,
Copyright Owners took note that the Services had relied on
substantively identical language in Johnson to support their argument
that other statements in that D.C. Circuit decision should be deemed
affirmed. See id. at 4-5 (noting Services' reliance on Johnson's
description of the Judges' rulings regarding student and family
discounts (``grounded in substantial record evidence . . . based on the
weight and credibility of the evidence [and] squarely within the
Judges' expertise)'' as demonstrating that the D.C. Circuit had
affirmed those rulings) (emphasis added); see also Copyright Owners'
Brief in Response to the Additional Materials Orders at 2, 6-7 (Jan.
24, 2022) (``CO Additional Submission'') (again asserting that ``the
15.1% revenue rate . . . was specifically affirmed in detail by
Johnson.'').
2. Services' Position
In their initial submission after the remand, the Services objected
to any continued application by the Judges of the 15.1% revenue rate
because, ``as the Majority acknowledged, this particular division of
revenues will never happen in the real world because of the
complementary oligopoly power of the record labels.'' Services' Joint
Opening Brief (in Services' Joint Written Direct Remand Submission at
Tab D) at 52 (``Services' Initial Submission'') (Apr. 1, 2021). More
particularly in this regard, the Services note that Professor Marx's
Shapley Value Model,\26\ which served as an input for the generation of
the 15.1% revenue rate, also indicated that only [REDACTED]% of the
interactive streaming revenue should be paid out as royalties to the
sound recording rightsholders, with the remaining [REDACTED]% of these
revenues retained by the interactive streaming services. Id. (``Both
Professor Marx's and Professor Watt's models show lower combined
royalties being paid by the services than are currently paid in the
marketplace. . . The discrepancy in total royalties between the models
and the real world is explained, in part, by the absence of supranormal
complementary oligopoly profits in the Shapley model, and the presence
of those profits in the actual market.''). Id. (quoting Phonorecords
III, 84 FR 1952).
---------------------------------------------------------------------------

\26\ Generally, a Shapley Value Model is a game theory analysis.
It models a hypothetical bargain that assigns each ``player'' the
average marginal value it contributes to the bargain and (after
accounting for the costs that each ``player'' would need to recover)
the remaining ``surplus'' is allocated among the players according
to their relative contributions. See Johnson, 969 F.3d at 372. For
the reasons discussed infra, in the present case, the Shapley
surplus from the streaming revenue is split essentially equally by
the owners of the sound recording and musical works owners inter se,
but the royalty rates themselves that would result from their
bargaining would be different as between these two inputs, because
of their differing costs. See, e.g., Gans WDT ] 73.
---------------------------------------------------------------------------

By this approach, the Services maintain, ``the Majority awarded the
Copyright Owners the full 15.1% of revenue dictated by its model
(phased in over time), and left it up to the Services to convince the
complementary oligopolist major labels to dramatically lower sound
recording rates.'' Id. at 54-55. The Services argue that, instead, the
Majority should have applied to Professor Marx's [REDACTED]% total
royalty obligation what they characterize as ``any of the[ ] real-world
ratios in place of the [REDACTED] ratio taken from ``Professor Gans'
``Shapley-inspired'' model. Id. at 54. According to the Services, these
lower ratios would have reduced the revenue percentage rate well below
15.1%. Id.
Alternatively, the Services propose, through Professor Marx's post-
remand written testimony, that the Judges now adopt ``a more balanced,
burden-sharing approach'' to address what she described as the
Majority's ``imbalance'' problem. Id. at 57; see also Marx WDRT ]] 52-
63.\27\ Essentially, her proposal begins with an assumption, based on
record evidence, that labels typically take specific shares of service
revenue, including shares of [REDACTED]%, [REDACTED]% and
[REDACTED]%.\28\ These shares are significantly higher than the
[REDACTED]% that Professor Marx generated from her Shapley model. Next,
Professor Marx's post-remand burden-sharing approach uses as inputs the
15.1% of service revenue and the [REDACTED]% of service revenue that
would be retained by the musical works owners and the Services
respectively.\29\ Putting these two factors together, she sets forth
the basic math: Using her [REDACTED]% sound recording share as an
example, she notes that there is not enough revenue for the labels to
take this [REDACTED]% share, if the musical works owners also receive
15.1% and the Services also retain the [REDACTED]% derived from her
model ([REDACTED]% + 15.1% + [REDACTED]% = [REDACTED]%, an irrational
result). See Services' Joint Opening Brief at 57.
---------------------------------------------------------------------------

\27\ Claiming consistency with the Majority's analysis,
Professor Marx appears to maintain that her ``burden-sharing''
approach generates the statutorily-required ``reasonable'' rate as
well as a rate that satisfies the ``fair return''/``fair income''
objectives of statutory Factor B. See Marx WDRT ] 52 (introducing
her correction of the alleged ``imbalance'' problem by noting that
``the ``right'' mechanical royalty rate is one that is
``reasonable'' and achieves the four objectives laid out in Section
801(b)(1).''
\28\ See Marx WDRT, fig. 7 ([REDACTED]).
\29\ The [REDACTED]% of revenue that the services would retain
is based on one of Professor Marx's ``Shapley Value Models.''
Shapley Value modeling is discussed infra.
---------------------------------------------------------------------------

Professor Marx engages in an analysis based on the following math
and logic (again, using the [REDACTED]% sound recording rate as an
example of the fixed amount taken by the labels): (1) [REDACTED]% of
the streaming revenues remain available to be split between the
services and the musical works copyright owners; (2) adding the 15.1%
revenue rate and her [REDACTED]% revenue retention percentage equals
[REDACTED]%; and (3) the 15.1% revenue rate, as a percent of this
[REDACTED]%, is [REDACTED]%; and (4) [REDACTED]% of the [REDACTED]%
available for splitting between the services and the musical works
copyright owners is [REDACTED]% (rounded). Id. at fig.8.
Thus, she identifies her version of a ``fair'' result: The Services
and Copyright Owners would split the residual revenue remaining after
the labels have exercised their complementary oligopoly power to take
an outsized fixed share--with the split proportional to the 15.1%-to-
[REDACTED]% revenue amounts calculated respectively by the Judges (the
15.1% musical works rate) and Professor Marx (the [REDACTED]% service
revenue retention). Id. 59, table. 8.\30\
---------------------------------------------------------------------------

\30\ Using the same logic and calculation method, Professor Marx
finds that the services would retain [verbar][REDACTED]% /
[REDACTED]%, which equals [verbar][REDACTED]%. Assuming again that
[REDACTED]% of the steaming revenue is available to split (because
the labels have appropriated [REDACTED]%), the services would retain
[REDACTED]% [REDACTED]% rounded) of the streaming revenue. Id.
---------------------------------------------------------------------------

In their final post-remand submission, the Services also flatly
state: ``[T]he D.C. Circuit did not ``affirm'' the 15.1% rate--it
vacated that rate.'' Services' Joint Rebuttal Brief Addressing the
Judges' Working Proposal at 2 (Feb. 24, 2022) (``Services' Additional
Submission''). However, the Services do not support that quoted
statement with any citation to Johnson. See id. Further, the Services
assert that the 15.1% revenue rate is not immune from post-remand
review and reduction because ``the D.C. Circuit withheld judgment ``on
whether that final percentage satisfies factors B through D of Section
801(b)(1). . . .'' Id. at 3.

[[Page 54412]]

3. Analysis and Decision Regarding 15.1% Revenue Rate Prong
The Judges determine that they are clearly bound by the D.C.
Circuit's decision in Johnson to maintain the 15.1% revenue rate, as
phased-in by the Determination. Several reasons support this decision.
First, the Judges conclude that the D.C. Circuit's decision in
Johnson is conclusive and unambiguous regarding the revenue percentage
rate. The D.C. Circuit rejected the Services' assertion that the Judges
acted ``arbitrarily'' as to this particular issue, noting that the
Services had misstated the relevant facts. Johnson, 969 F.3d at 385-86
(responding to Services' misdescription of Judges' analysis and
explaining what Services described as ``not what happened.'').
Moreover, the D.C. Circuit held that with regard to the construction of
the 15.1% revenue rate, the Judges had ``engaged in the type of line-
drawing and reasoned weighing of the evidence [which] falls squarely
within the [Judges'] wheelhouse as an expert administrative agency.''
Id. at 386. The D.C. Circuit further noted that the Judges
``proceed[ed] cautiously'' to set the 15.1% revenue rate by
establishing a ``zone of reasonableness'' for the revenue rate. Id. at
385. Indeed, with regard to each aspect of this revenue rate analysis,
the D.C. Circuit found that the Judges' decision making was ``grounded
in the record and supported by reasoned analysis'' and that
``[s]ubstantial evidence supports [their] judgment.'' Id. at 385.
Second, when the D.C. Circuit reviewed the Determination, it
applied ``the same standards set forth in the Administrative Procedure
Act, 5 U.S.C. 706.'' Id. at 375 (noting that 17 U.S.C. 803(d)(3) cross-
references 5 U.S.C. 706); see also id. (``[W]e will set aside the [ ]
Determination `only if it is arbitrary, capricious, an abuse of
discretion, or otherwise not in accordance with law, or if the facts
relied upon by the agency have no basis in the record.'').
Here, the D.C. Circuit explicitly found that the Judges' analysis
and findings in connection with the 15.1% revenue rate are not
arbitrary and capricious, and that the facts relied upon by the Judges
have a sufficient basis in (are ``grounded in'') the record. It seems
beyond dispute that the D.C. Circuit affirmed the Judges in their
setting of the 15.1% revenue rate as a rate that is reasonable, and
thus satisfies that aspect of the section 801(b)(1) standard.\31\
Indeed, it would border on the Orwellian to misconstrue the D.C.
Circuit's unequivocal and obvious affirmance of the reasonableness of
the 15.1% revenue rate as a vacating of that finding.
---------------------------------------------------------------------------

\31\ The CRB Judges intentionally distinguish between the
``reasonable'' rate standard in the initial body of section
801(b)(1) and the objectives set forth as Factors A-D of section
801(b)(1). A rate can satisfy the statutory ``reasonable rate''
requirement yet require adjustment (higher or lower) to reflect the
balancing of the four additional factors. Accordingly, the Judges
defer to a subsequent section, infra, a discussion of how Factors A-
D should be addressed on this remand.
---------------------------------------------------------------------------

Third, the Judges note that Johnson conspicuously declines to
identify the Judges' setting of the 15.1% percent-of-revenue rate as
one of the findings to be revisited on remand. Rather, Johnson states
that the three overarching issues for resolution on remanded are the
Majority's failure: (1) ``to provide adequate notice of the rate
structure it adopted,'' (2) ``to explain its rejection of a past
settlement agreement as a benchmark for rates going forward; and (3)
``[to] identif[y] the source of its asserted authority to substantively
redefine a material term after publishing its Initial Determination.''
Johnson, 369 F.3d at 367. The Majority's finding that the 15.1% royalty
rate is ``reasonable'' was not identified by the D.C. Circuit as a
finding that was vacated and subject to further review and, indeed, as
noted supra, the appellate panel credited what it characterized as the
Majority's careful analysis and line-drawing in arriving at that
finding.
The clarity of the D.C. Circuit's affirmance of the royalty rate of
15.1% for the percent-of-revenue prong moots the issue of whether
Professor Marx's attempt, described supra, to correct the so-called
``imbalance'' problem has merit. However, the Judges note that, even if
this issue had not been conclusively decided in Johnson, they would
reject her approach as futile. That is, Professor Marx fails to
acknowledge that any surplus that her approach would appear to provide
to the Services would be siphoned off by the Majors, given their
complementary oligopoly power.
More particularly, the sound recording royalty rates she posits
([REDACTED]%, [REDACTED]% and [REDACTED]%) are all functions of the
sound recording companies' understanding of the Services' non-content
costs (costs that the Services must recover out of retained revenues in
order to remain in operation, i.e., to ``survive'') and the then-
existing musical works content (royalty) costs (comprised of the
mechanical rate and the performance rate). If, as Professor Marx
contemplates, the mechanical rate is reduced so that Copyright Owners
``share the burden'' of the complementary oligopoly effect on sound
recording rates, that ``burden sharing'' would increase the revenues
retained by the Services (that is the purpose of Professor Marx's
approach!). But such an increase would raise the Services' revenue
above their ``survival'' rate, as understood by the record labels.
Thus, the record labels, given their complementary oligopoly power,
would increase the Services' royalty rate above what it otherwise would
have been.
Alternately stated, when Professor Marx hypothesizes a given sound
recording royalty rate in column 1 of Figure 8 in her WDRT, that rate
is assumed, by the logic of the complementary oligopoly theory, to have
already allowed the services to cover only their non-content costs and
musical works royalties, as understood by the record labels. So, her
assumed rate in column 1 is not a fixed parameter, but rather an
independent variable, which is a function of, inter alia, the costs
incurred by the services, i.e., their non-content costs plus their
musical works royalty costs.\32\ If those service costs decreased (for
example, in an attempt to reduce the services' burden of bearing the
full brunt of the labels' complementary oligopoly power as in Professor
Marx's attempt to correct the imbalance problem), the percentage in
column 1 of Figure 8 would increase, as the labels siphoned off that
surplus over the services' survival revenue requirements. To find
otherwise would be to refute the logic of the dynamics of the
complementary oligopoly effect.\33\
---------------------------------------------------------------------------

\32\ The interactive services also pay a separate royalty for
the performance license necessary to transmit a song. However, under
the Judges' ``All-In'' royalty structure, that performance royalty
is deducted from the ``All-In'' calculation to determine the
mechanical royalty. Also, the performance royalty paid to the
largest Performing Rights Organization (PROs) are subject to
determination by federal judges in the Southern District of New York
(the so-called ``rate court'').
\33\ To be clear, the Judges are not stating that the Services'
retention of only enough revenue to allow them to cover their
noncontent costs and thus merely ``survive'' is indicia of an
effectively competitive (or even healthy) market--but are merely
acknowledging the state of affairs given the unregulated nature of
the sound recording royalties and the complementary oligopoly power
that exists in that market.
---------------------------------------------------------------------------

Moreover, the defect in Professor Marx's attempt to remedy the so-
called ``imbalance'' problem is a consequence of the statutory
licensing and royalty scheme. To recap, the licensing of content used
by the interactive services is bifurcated. The sound recording
royalties paid by the interactive services to the record labels are not
regulated, and complementary oligopoly power exists in that market,
inflating sound recording royalty rates above an effectively
competitive level. See

[[Page 54413]]

Determination at 73 (``[T]he existence of complementary oligopoly
conditions in the market for sound recordings'' is the basis for ``the
record companies' ability to obtain most of the available surplus''
generated by interactive streaming.) \34\ However (and to state the
obvious), the mechanical rate paid by the interactive services for
musical works is regulated, pursuant to 17 U.S.C. 115 and, until the
2018 enactment of the Music Modernization Act,\35\ according to the
rate standards in 17 U.S.C. 801(b)(1). Thus, there is no statutory or
regulatory impediment to prevent record labels from responding to a
decrease in the mechanical rate by increasing the unregulated sound
recording rate if such an increase is in their economic interest.\36\
---------------------------------------------------------------------------

\34\ As the Judges have consistently noted, this complementary
oligopoly power is generated by the concentration of ownership of
sound recording licenses for ``Must Have'' repertoires among the
three Majors (Sony Music Group, Warner Music Group and Universal
Music Group), plus Merlin (a consortium of Indies sometimes referred
to as ``the fourth Major''), as indicated by their reported
collective 85% share of Spotify's streams in 2018, the first year of
the rate period at issue here. See <a href="https://www.midiaresearch.com/blog/smaller-independents-and-artists-direct-grew-fastest-in-2020">https://www.midiaresearch.com/blog/smaller-independents-and-artists-direct-grew-fastest-in-2020</a>.
\35\ In subsequent rate periods, the rate remains regulated, but
is subject to a different standard--the ``willing buyer-willing
seller marketplace standard,'' for shorthand) under 17 U.S.C. 115.
\36\ The inverse relationship between changes in the mechanical
royalty rate and changes in the sound recording royalty rate has
been characterized as the ``seesaw'' effect, which is discussed in
further detail infra, with regard to the uncapped TCC rate prong.
---------------------------------------------------------------------------

Accordingly, any attempt by the Judges to reduce the mechanical
royalty rate in order to allow the Services to retain more of the
surplus would fail; it would be like pouring water into a bucket with a
siphon at its base. More water would not remain in the bucket, but
rather would accumulate wherever the siphon leads--in this case, to the
record labels. The Judges could keep mechanical royalty rates depressed
and allow this to occur, but that would harm Copyright Owners while
providing no relief to the Services. And despite the old adage that
``misery loves company,'' the Judges detect no directive under section
801(b)(1) that they harm Copyright Owners without providing a gain for
the interactive streaming services--and that they provide a windfall
for the record labels, to boot.
Although Professor Marx's attempt to reduce the Services'
``misery'' by sharing it with Copyright Owners is unavailing, the
statutory scheme and market forces do appear to combine to mitigate the
burden created by the complementary oligopoly power of the sound
recording companies. If interactive streaming revenue were to grow over
the rate period,\37\ then the phase-in to the 15.1% rate will reflect
fixed annual percentages of a larger base, allowing services to retain
a higher dollar level of the interactive streaming revenues.\38\
[REDACTED]. See, e.g., Diab WDRT ]] 10-11 (Google agreements);
Mirchandani WDRT ]] 16-17 (Amazon agreements); Bonavia WDRT ]] 8; 14-19
(Spotify agreements); White WDRT ]] 6; 8-14; 19; 24; 27-28 (Pandora
agreements). Additionally, the Services' headline sound recording rates
[REDACTED]. Services' Joint Remand Reply Brief at 40 (and record
citations therein). Thus, assuming no increase in non-content costs (or
increases smaller than the increases in streaming revenue), the
Services will realize increased revenue above and beyond what they
needed to survive.
---------------------------------------------------------------------------

\37\ Because this proceeding was appealed and remanded, the
Judges have the benefit of knowing the ``future'' (beyond 2017),
during which U.S. interactive streaming revenues have continued to
grow, a fact that is undisputed, and as to which the Judges take
administrative notice. See, e.g., RIAA 2018 Year-End Music Industry
Revenue Report (available at <a href="https://www.riaa.com/wp-content/uploads/2019/02/RIAA-2018-Year-End-Music-Industry-Revenue-Report.pdf">https://www.riaa.com/wp-content/uploads/2019/02/RIAA-2018-Year-End-Music-Industry-Revenue-Report.pdf</a>; RIAA 2020 Year-End Music Industry Revenue Report
(available at <a href="https://www.riaa.com/wp-content/uploads/2021/02/2020-Year-End-Music-Industry-Revenue-Report.pdf">https://www.riaa.com/wp-content/uploads/2021/02/2020-Year-End-Music-Industry-Revenue-Report.pdf</a> (interactive streaming
revenue increased within this rate period from (approximately) $1.6
billion in 2018 to $7.7 billion in 2019 and $8.8 billion in 2020).
\38\ For example, if a royalty is set at a flat rate of 15.1%
when a revenue base is $1,000, then the royalty is $151, leaving
$849 in revenues to cover other costs which, for this example, are
held constant. If the revenue base doubles to $2,000, the same flat
15.1% royalty rate generates $302 in royalties, leaving $1,698 in
revenues to cover other costs which, if constant, allow for the
additional revenue ($1,698-$849 = $849) to generate profits.
---------------------------------------------------------------------------

The Services and Copyright Owners recognize the mitigation of harm
to the Services generated by these facts (although they may well
disagree with the Judges' application of these facts). During colloquy
with counsel for Pandora and Spotify during closing arguments on
remand, the Judges asked why they should in essence apply the ``misery
loves company'' adage:

[JUDGE STRICKLER] [T]he problem is . . . the sound recording
[rates] are unregulated in the interactive market . . . . Congress
did not want that to be controlled at all. So every time I see . . .
the services' argument about how we have [to] set a rate that's fair
even though there's this ability of the sound recording [companies]
to take more, my margin note is always this: ``Are they arguing that
`misery loves company?' '' [W]hy shouldn't that misery be shared
with Copyright Owners? . . . Isn't that really Professor Marx's
argument in her proposed split . . . using the 15.1 percent figure .
. . ?
[COUNSEL] [Regarding] Judge Strickler['s] . . . ``misery loves
company'' issue. . . . I think . . . the way [Judge Strickler] put
it during the trial was, even if I thought rates needed to come
down, how would that help you; wouldn't the labels just take all
that surplus for themselves based on their complementary oligopoly
power? . . . . I want[ ] to address it right off the bat . . . . in
open session.
Relat[ed] to . . . the seesaw . . . our point is that these
label rates are sticky in both directions. If you see an increase in
musical works rates, you do not see a quick decrease in label rates,
and the opposite is true. These rates are sticky.
. . .
There's a lot of friction with respect to the ability of label
rates to change quickly in response to the dynamic marketplace or
the dynamic for business reasons or because of regulatory changes in
musical works rate. These are multi-year contracts. They take a long
time to negotiate. They are complex, et cetera.
So, I do think it's right that at a minimum you can buy time
where the ratio is more aligned with the 801(b) factors. In other
words, you don't have to worry that the labels will take it all
right away, even if you believe they will ultimately take that.
[JUDGE STRICKLER] So you are saying we have something that
reduces misery for a period of time until the misery returns?
[COUNSEL] That's right. And I think that would have been true in
2018 when you were sitting drafting the decision. It's even more
true today in 2022 when the label rates, as I mentioned, are
effectively set, bought and paid for.

3/8/22 Tr. 29-30, 43-46 (Closing Argument) (emphasis added).
Similarly, on this topic, Copyright Owners' counsel accurately
characterized the Judges' adoption of the static 15.1% Shapley-based
rate as the inevitable consequence of ``regulatory lag,'' that requires
a regulator to keep a rate constant over the statutory term because
there is no sufficient data to project future rates. Id. at 273-75; see
generally A. Kahn, 2 The Economics of Regulation at 48 (1971) ``The
regulatory lag [is] the inevitable delay that regulation imposes in the
downward . . . [and] upward adjustments'' to rate levels, and ``thus is
to be regarded not as a deplorable imperfection of regulation but as a
positive advantage [because] companies can for a time keep the higher
profits they reap from a superior performance. . . .'').\39\
---------------------------------------------------------------------------

\39\ The Judges emphasize two points that mitigate any negative
impact on Copyright Owners from the static nature of the 15.1%
revenue rate. First, as a percent-of-revenue rate, it generates more
royalty revenue in a growing market, so the quantum of revenue is
not static. Second, Copyright Owners' own economic expert witness,
Professor Gans, testified that the data in the ``market
observations'' from the Goldman Sachs Report on which he relied were
the result of ``negotiated rates in the free market and thus
``presumed to . . . fully consider[ ] . . . expectations of future
costs and revenues . . . . incorporate[ing] expectations of future
values.'' Gans WRT ]] 37-38. On this issue, it is noteworthy that
both the Majority and the D.C. Circuit credited Professor Gans's
reliance on these projections. See Determination at 70 (``The Judges
. . . find Professor Gans' reliance on financial analysts'
projections for the respective industries to be reasonable.'');
Johnson, 969 F.3d at 386 (holding that ``[t]he CRB Judges' finding
that Gans's . . . reliance on Goldman Sachs' profit projections''
was ``reasonable'' and the] . . . type of line-drawing and reasoned
weighing of the evidence [that] falls squarely within the [Copyright
Royalty Board's] wheelhouse as an expert administrative agency.'')
Thus, dynamic changes going forward in the rate term are
embodied in the 15.1% revenue rate, and dynamic market expectations
are incorporated in the modeling data used to establish that rate.

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[[Page 54414]]

4. Consideration of Factors A-D in Section 801(b)(1)
Finally, the Judges consider the impact of Factors A-D of section
801(b)(1) in connection with the setting of the revenue percentage rate
of 15.1%.\40\ Regarding Factor A, it cannot be gainsaid that the D.C.
Circuit has left this issue unresolved. Rather, Johnson unambiguously
affirmed the Majority's finding that an increase in the mechanical
royalty rate was warranted. Specifically, Johnson states that the
Majority's decision in this regard met the ``test'' that it be
``supported by substantial evidence [and] reflect a reasonable reading
of the record.'' Johnson, supra, at 388. Moreover, with regard to the
level of the increase, the D.C. Circuit did not disturb the finding by
the Majority that ``[t]he rates determined by the Judges represent a
44% increase over the current headline rate, and thus satisfies the
Factor A objective. . . .'' Determination at 85.\41\
---------------------------------------------------------------------------

\40\ The D.C. Circuit ruled, with regard to the ``nature of the
rate structure,'' that because it had ``vacat[ed] and remand[ed] . .
. for lack of notice'' ``[t]he question whether the [Judges]
adequately addressed factors B through D is bound up with the
[Judges'] analysis of sound recording rightsholders' likely
responses to the new rate structure.'' Johnson, supra, at 389.
However, the 15.1% revenue rate, viewed separately, is not bound up
in the ``rate structure'' issue, which relates to the uncapped TCC
prong and how the 15.1% revenue rate may be ``intertwined'' with
that second rate prong. As explained infra, the Judges are not
adopting an uncapped TCC rate prong, so the 15.1% rate is no longer
``bound up'' with the vacated and remanded ``rate structure'' issue,
making moot the argument that a new post-remand analysis of Factors
B through D is necessary or appropriate. However, on remand,
Copyright Owners have placed in issue the ``disruption'' element of
Factor D, claiming that the Services have not proven that the
uncapped TCC rates and rate prong have or will cause disruption.
\41\ The 44% figure cited by the Majority reflects the
percentage increase of the headline rate, from 10.5% to 15.1%.
---------------------------------------------------------------------------

With regard to Factors B and C,\42\ even if Johnson were construed
as permitting the Judges to revisit this issue, they would not adjust
the 15.1% revenue rate on the basis of these two factors. In this
regard, the Judges note that the Majority found that the 15.1% revenue
rate was not only ``reasonable,'' but also a ``fair allocation of
revenue between copyright owners and services.'' Determination at 87
(emphasis added). The Majority thus found explicitly that ``with regard
to Factors B and C . . . there is no basis to depart from [its]
determination of the reasonable . . . rate structure and rates as set
forth supra.'' Id. More particularly, the Majority calculated the 15.1%
rate by utilizing the total royalty percentage revenue of only
[REDACTED]% as calculated by Spotify's economic expert witness,
Professor Marx, whose economic modeling intentionally reflected a
conception of fairness by reducing the effect of the labels'
complementary oligopoly market power. See Determination at 67-68
(noting that Professor Marx testified that this aspect of her model
``represents a fair outcome in the absence of market power [and] . . .
eliminates . . . market power'' which . . . if left in the economic
analysis would ``render[ ] . . . the analysis incompatible with the
objectives of Factors B and C of section 801(b)(1).)'') (emphasis
added).\43\
---------------------------------------------------------------------------

\42\ Factors B and C are typically considered jointly, because
of the overlap in the objectives of providing a ``fair return'' and
a ``fair income'' to the licensors and licensees respectively (the
Factor B objectives) and reflecting their relative roles in making
the streamed music available to the public (the Factor C
objectives). See Johnson, 969 at 388 (noting without criticism the
joint consideration of Factors B and C; Determination at 85-86
(noting without criticism the several experts' joint consideration
of Factors B and C).
\43\ Additonal facts support the Majority's finding that the
15.1% revenue rate is fair. The record evidence indicates that the
headline percent-of-revenue sound recording rate was between
approximately [REDACTED]% to [REDACTED]% in 2017. See Marx WDRT ]
58, fig 7. When the 15.1% mechanical rate is added to that rate
range, the range of the total royalty obligation (based on headline
rates) is [REDACTED]% to [REDACTED]%. (Plus, given the phase-in of
the rates expressly to avoid disruption, the total royalty
obligation would be even lower before 2022, at current sound
recording rates.) The evdence pre-remand indicated that the Services
were ``surviving'' while incurring noncontent of costs of
approximately [REDACTED]% of revenue, leaving about [REDACTED]% of
revenue available to pay royalties while still remaining in
business. See Eisenach WRT ] 79 (Copyright Owners' expert economic
witness); McCarthy WDT ]] 28-29 (Spotify's Chief Financial Officer.)
Thus, even if the Judges were to engage in a de novo analysis of the
potential applicability of Factors B and C to the 15.1% rate, they
would not find any basis sufficient to warrant a downward rate
adjustment, beyond the phase-in adopted in the Determination.
---------------------------------------------------------------------------

Accordingly, the Judges find it would be substantively unwarranted
to engage in any new consideration on remand of the impact, if any, of
Factors B and C on the otherwise reasonable 15.1% revenue rate.\44\
---------------------------------------------------------------------------

\44\ However, the Judges take note of their further observation,
discussed supra, that the combined impact of ``sticky'' sound
recording royalty rates and the inevitable regulatory lag provide an
additional modicum of fairness with regard to the mechanical royalty
rate.
---------------------------------------------------------------------------

The final itemized statutory factor--Factor (D)--instructs the
Judges to consider the ``competing priority'' of ``minimiz[ing] any
disruptive impact on the structure of the industries involved and on
generally prevailing industry practices.'' 17 U.S.C. 801(b)(1)(D). As
with Factors B and C, even if Johnson were construed to allow the
Judges to revisit this issue on remand with respect to the 15.1%
revenue rate, the Judges would not change the Majority analysis or
findings. In the Determination, the Judges adopted the following
interpretation of this standard set forth in previous determinations:

[T]he Judges reiterated their understanding of Factor D,
concluding that a rate would need adjustment under Factor D if that
rate directly produces an adverse impact that is substantial,
immediate and irreversible in the short-run because there is
insufficient time for either [party] to adequately adapt to the
changed circumstance 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.

Determination at 86 (emphasis added).
Also, in order to minimize any economic disturbance to the
Services' businesses, the Majority decided to phase-in the 15.1% rate
over the five-year rate term, setting annual percent-of-revenue rates
as follows: 11.4% in 2018; 12.3% in 2019; 13.3% in 2020; and 14.2% in
2021, before the full 15.1% rate became effective in 2022 the final
year of the rate term. Id. at 87-88.
On remand, the Services have not made any argument that the rate
structure or rates set by the Majority were ``disruptive under this
standard.'' \45\ In sum, there is insufficient basis for the Judges to
change the Majority's application of Factor (D) to the 15.1% revenue
rate finding by the Majority.\46\
---------------------------------------------------------------------------

\45\ The Judges further discuss the Factor D ``disruption issue
infra in connection with their analysis of the uncapped TCC prong.
\46\ Additional facts further support the Majority's finding
that the 15.1% revenue rate is would not be disruptive under Factor
D. The record evidence indicates that the headline percent-of-
revenue sound recording rate was between approximately [REDACTED]%
to [REDACTED]% in 2017. See Marx WDRT ]] 14, 19. When the 15.1%
mechanical rate is added to that rate range, the range of the total
royalty obligation (based on headline rates) is [REDACTED]% to
[REDACTED]%. (Plus, given the phase-in of the rates expressly to
avoid disruption, the total royalty obligation would be even lower
before 2022, at current sound recording rates.) The evidence pre-
remand indicated that the Services were ``surviving'' while
incurring noncontent costs of approximately [REDACTED]% of revenue,
leaving about [REDACTED]% of revenue available to pay royalties
while still remaining in business. See Eisenach WRT ] 79 (Copyright
Owners' expert economic witness); McCarthy WDT ]] 28-29 (Spotify's
Chief Financial Officer). Thus, even if the Judges were to engage on
remand in a de novo analysis of the potential applicability of
Factor D to the 15.1% rate, they would not find any disruption
sufficient to warrant a downward rate adjustment, beyond the phase-
in adopted in the Determination.

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

[[Page 54415]]

5. Conclusion Regarding the 15.1% Revenue Rate
For the forging reasons, the Judges do not disturb the Majority's
finding that the percent-of-revenue rate at 15.1%, phased-in annually
over the rate period, constitutes a ``reasonable'' rate under section
801(b)(1) to be used as the statutory rate for the 2018 to 2022
period.\47\
---------------------------------------------------------------------------

\47\ The Services' assert that the Judges previously found that
the reasonableness of the 15.1% rate was subject to revision on
remand. In support of this position, the Services cite to the
Judges' Order Granting in Part and Denying in Part Copyright Owners'
Motion for Reconsideration or, in the Alternative, Clarification at
3, 4 n.7 (January 6, 2022) (Jan. 6th Order). But the Judges said in
that interlocutory proposal merely that Copyright Owners were
incorrect in their extreme assertion that the Judges could not make
an ``alternative rate and rate structure finding . . . except for
the re-adoption of the vacated rate and rate structure approach in
the Phonorecords III Determination [because] . . . [t]hat . . .
would . . . be inconsistent with Johnson [and] . . . would render
the D.C. Circuit's vacating and remanding of the proceeding without
force or effect.'' Id. at 4, n.7. That did not mean that certain
elements of the D.C. Circuit's ruling could be ignored. Further,
when the Judges provided the parties with the Judges' explicitly
tentative ``Working Proposal,'' they did not declare that the 15.1%
revenue rate calculation could be revisited. Rather, the Judges
``express[ed] a concern, not that the foregoing calculations could
be overridden, but rather that this analysis . . . is `incomplete' .
. .'' Jan. 6th Order at 6 (emphasis added). The parties' submissions
in response to the Judges' ``Working Proposal'' demonstrated that
the 15.1% revenue rate calculation was not ``incomplete'' in the
manner that had raised the Judges' concern. Nothing the Judges said
in this interlocutory and tentative ``Working Proposal'' constituted
a definitive statement regarding the Judges' view of what was and
was not subject to review on remand. See generally <a href="http://merriam-webster.com">merriam-webster.com</a> (defining the adjective ``working'' in this context as
``assumed or adopted to permit or facilitate further work or
activity . . . a working draft.''). Indeed, a primary purpose of the
``Working Proposal'' was to allow the Judges and the parties to
address potential issues and resolutions, without prejudice going
forward.
---------------------------------------------------------------------------

D. Uncapped TCC Rate Prong

1. Two Post-Remand Rationales for Uncapped TCC Rate Prong
The Determination set forth the following two primary reasons for
adopting a ``greater-of' rate structure that also included an uncapped
TCC rate prong:

First, the use of an uncapped TCC metric is the most direct
means of implementing a key finding . . . by the experts for
participants on both sides in this proceeding: the ratio of sound
recording royalties to musical works royalties should be lower than
it is under the current rate structure. Incorporating an uncapped
TCC metric into the rate structure permits the Judges to influence
that ratio directly.
Second, an uncapped TCC rate prong effectively imports into the
rate structure the protections that record companies have negotiated
with services to avoid the diminution of revenue.

Determination at 35-36.\48\
---------------------------------------------------------------------------

\48\ The Majority added two other reasons that are not germane
to this remand. In particular, the Majority stated that, compared to
the Phonorecords II benchmark proposed by the Services, the
``greater-of'' structure with the uncapped TCC rate prong was
``simpler'' to understand than the ``Rube Goldberg-esque'' nature of
the Phonorecords II rate structure. Id. at 36. This issue apparently
was not raised on appeal, as it was not mentioned in Johnson, and
Copyright Owners have not raised the issue on remand. See CO Initial
Submission, supra. (However, the Judges do consider this issue in
their analysis of the PR II-based benchmark, infra.) The final
reason provided by the Majority was that its adoption of an uncapped
TCC rate prong was supported by evidence of Google's agreements with
labels that included an uncapped rate structure, on which Google had
relied to propose, post-hearing, the same greater-of rate structure.
Id. However, the D.C. Circuit found that Google's proposal was
distinguishable, as it was based on a far lower TCC rate (15%) as
well as a far lower percent-of-revenue rate (10.5%). The D.C.
Circuit thus declined to rely on the Google-based approach as
support for the uncapped TCC rate prong. Johnson, 969 F.3d at 383.
---------------------------------------------------------------------------

2. Copyright Owners' Position
Copyright Owners claim that the uncapped TCC prong should be
adopted. They contend that the D.C. Circuit remand was merely
``procedural'' rather than substantive, and the Judges thus are not
precluded from readopting the uncapped TCC prong in this remand
proceeding. CO Initial Submission at 35-38 (and record citations
therein).
They further contend that the uncapped TCC prong was adopted to
provide protection against revenue deferment and displacement
occasioned by the Services choosing to elevate the growth of
subscribers and other listeners over revenue maximization. Id. at 38-43
(and record citations therein). The uncapped TCC prong was first
proposed by Google to persuade the Judges to reject Copyright Owners'
proposed ``greater-of'' rate structure containing a per-play prong and
a per subscriber prong. Id. at 43-46 (and record citations therein).
Copyright Owners argue that the uncapped TCC prong should be
adopted because: (1) the Services have not shown any actual or
threatened ``disruption'' or other harm resulting from the uncapped TCC
prong during the 33-month period; (2) the Services actually experienced
``unprecedented growth and profit'' during this period; and (3) the
Services paid lower percentages of revenues in mechanical and total
royalties when the uncapped TCC prong was in effect. Copyright Owners'
Reply Brief on Remand at 34-48 (and record citations therein).
Relatedly, according to Copyright Owners the Services' argument
that the ``see-saw'' effect is unsupported by empirical evidence has
collapsed, given the evidence relating to market performance. Further
Copyright Owners maintain that this argument is irrelevant to the rate
structure issue. Id. at 48-50 (and record citations therein).
3. Services' Position
The Services argue on remand that the uncapped TCC rate prong must
be rejected. The Services reject the ``seesaw'' theory claiming it is
disproved by the experience of the parties during the 33-month period.
Services' Joint Opening Brief at 48-49; Services' Joint Supplemental
Brief at 7-13 (Nov. 15, 2021) (and record citations therein). The
Services further contend that Copyright Owners have disavowed the
``seesaw'' theory as understood by the Majority. The Services allege
that Copyright Owners now claim that the theory was nothing more than
``a nod'' to certain ``core principles'' of bargaining theory, rather
than a specific prediction of a commensurate inverse relationship
between increases in the mechanical royalty rate and decreases in the
sound recording royalty rate. Services' Joint Supplemental Brief at 2,
5-7 (and record citations therein).
With regard to the uncapped TCC rate prong, the Services assert
that Copyright Owners have not even attempted to demonstrate--nor could
they demonstrate--that the uncapped TCC rate prong is consistent with
all four statutory objectives set forth in section 801(b)(1). Services'
Joint Reply Brief at 1, 3-4, 33-34 36 (July 2, 2021) (``Services'
Reply''); see also Services' Joint Opening Brief at 44-64 (and record
citations therein). The Services claim that ``yoking'' the mechanical
rate to the ``complementary oligopoly rates extracted by the labels is
plainly unreasonable.'' Services' Joint Opening Brief at 44-46. The
Services argue that the existence, vel non, of any ``disruptive
impact'' arising from the uncapped TCC rate prong, is misguided and not
dispositive, because it is only one of the four separately itemized
factors and, as this factor relates to Copyright Owners' proposed
uncapped TCC prong, they bear the burden of proof. Services' Reply at
35-37.
Finally, the Services contend that Copyright Owners have failed to
explain their self-contradictory pre-remand argument that ``an uncapped
TCC prong `does nothing to protect Copyright Owners from the Services'
revenue

[[Page 54416]]

displacement and deferment.' '' Services' Reply at 43.
4. Application of Johnson Findings Regarding Uncapped TCC Rate Prong
The Judges conclude that the D.C. Circuit affirmed the Majority's
derivation and calculation of the 26.1% TCC rate, but vacated and
remanded the Judges' application and inclusion of that rate prong in
the rate structure. The D.C. Circuit noted that, on appeal, the
Services contended that ``it was arbitrary and capricious for the
[Judges] to rely on information drawn from different expert analyses in
calculating the mechanical royalty rates.'' Johnson, 969 F.3d at 384.
Thus, the Services were making the same ``information''-based argument
in opposition to the calculation of both aspects of the mechanical
royalty rates--the revenue percentage prong and the TCC prong. See also
id. (``the Streaming Services separately leveled objections to the
particular percentages adopted by the Copyright Royalty Board to
calculate the revenue and total content cost prongs.'') (emphasis
added)
In fact, both rate prongs were indeed derived from the same
analyses. See Determination at 75 (table) (showing that both 15.1%
revenue rate and 26.2% TCC rate derived from same data--Professor
Marx's model showing total royalties as high as [REDACTED]% [Majority's
lower bound] and Professor Gans's ``Shapley-inspired'' model showing
TCC percent should be [REDACTED]%.) \49\
---------------------------------------------------------------------------

\49\ The reciprocal of Professor Gans's [REDACTED]ratio of sound
recording:musical works royalties is [REDACTED], or [REDACTED]%.
---------------------------------------------------------------------------

It is also clear from Johnson that the D.C. Circuit found that the
Majority had reasonably derived and calculated the 26.2% TCC rate:

When it came to . . . the ratio of sound recording to musical
work royalties that Gans derived from his analysis the [CRB Judges]
specifically found . . . reasonable Gans' equal value assumption
[for dividing the Shapley surplus . . . between sound recording and
musical works owners] and his reliance on Goldman Sachs' profit
projections. That type of line-drawing and reasoned weighing of the
evidence falls squarely within the Board's wheelhouse as an expert
administrative agency.

See Johnson, 969 F.3d at 385-86 (cleaned up) (emphasis added).
Accordingly, because the identical analysis was performed by the Judges
to derive the 26.2% TCC rate as was done to derive the 15.1% revenue
rate, the Majority's finding with regard to the derivation and
calculation of the TCC rate likewise is not subject to further
consideration on remand by the Judges.
However, it is equally clear that the D.C. Circuit vacated and
remanded the Majority's application and inclusion of the 26.2% TCC rate
in a separate ``greater-of'' TCC prong. The defect that generated the
vacating on this issue was procedural-- ``the Streaming Services had no
notice that they needed to defend against and create a record
addressing such a significant, and significantly adverse, overhaul of
the mechanical license royalty scheme . . .'' Id. at 382. The
consequence of the D.C. Circuit's action, however, was substantive. The
D.C. Circuit stated:

This is no mere formality. Interested parties' ability to
provide evidence and argument bearing on the essential components
and contours of the [Judges'] ultimate decision not only protects
the parties' interests, it also helps ensure that the [Judges']
ultimate decision is well-reasoned and grounded in substantial
evidence. . . .
The Streaming Services separately challenge the uncapped rate
structure as arbitrary and capricious. In particular, they argue
that the rate structure formulated by the [Judges] failed to account
for the sound recordings rightsholders' market power. They also
object that the [Judges] failed to provide a `satisfactory
explanation, or root in substantial evidence, [their] conclusion
that an increase in mechanical license royalties would lead to a
decrease in sound recording royalties [the ``inverse relationship''
a/k/a the ``seesaw'' effect].

Id. at 381-83 (cleaned up) (emphasis added). Thus, the D.C. Circuit
explicitly declined to address these substantive issues, because of the
deficient procedure. Instead, the D.C. Circuit remanded these
substantive issues back to the Judges. Id. Simply put, Johnson found
that the absence of notice here could be outcome-determinative. Thus,
the Judges categorically reject Copyright Owners' assertion that the
remand as to the uncapped TCC rate structure was merely ``procedural.''
The Judges do not accept the notion that the Majority simply committed
some ministerial faux pas that could be summarily corrected so that the
uncapped TCC rate structure could be rubber-stamped on remand. Rather,
the Judges' error rendered it impossible for them to consider the pros
and cons of such a rate structure without the necessary input from the
Services (and, for that matter, Copyright Owners as well).
Because the procedural infirmity precluded the D.C. Circuit from
deciding whether the Majority's decision was ``well-reasoned and
grounded in substantial evidence,'' there also can be no substantive
presumption of the appropriateness of the uncapped TCC rate prong, as
suggested by Copyright Owners. To the contrary, the D.C. Circuit's
opinion makes it clear that on remand the Judges must engage in a fresh
consideration of the statutory appropriateness, vel non, of the
uncapped TCC rate prong, by weighing and contextualizing the competing
evidence and testimony entered into the record both before and after
the remand.
Accordingly, although Copyright Owners correctly assert that
Johnson did not find the uncapped TCC rate structure to be ``unfair,
unreasonable or inequitable,'' Johnson just as clearly did not find
that structure to be ``fair, reasonable or equitable.'' Rather, the
purpose of the remand was for the Judges to make these determinations.
Accordingly, the Judges next examine whether setting the statutory
mechanical rate as an uncapped TCC rate is ``reasonable,'' as required
by section 801(b)(1).\50\
---------------------------------------------------------------------------

\50\ The Judges consider infra whether any of the four itemized
statutory factors require an adjustment to this analysis.
---------------------------------------------------------------------------

5. Determining Whether Uncapped TCC Rate Prong is ``Reasonable''
a. Rejection of First Rationale for Including Uncapped TCC Rate
Two substantive issues are implicated raised with regard to the
issue of reasonableness: (1) whether the ``seesaw'' theory is valid;
and (2) if it is valid, whether there exist sufficient data to support
the phased-in 26.2% uncapped TCC rate.\51\ To demonstrate that this
uncapped TCC rate prong and the (phased-in) 26.2% rate are reasonable,
Copyright Owners rely on the combined application of two economic
models--the Shapley Value model and a Nash Bargaining Model.
Accordingly, it is necessary to consider how these two models relate to
each other and how these models and their interrelationship impact the
setting of the statutory rate.
---------------------------------------------------------------------------

\51\ As noted supra, in the Judges' recitation of the parties'
remand arguments regarding the uncapped TCC rate prong, they make
other arguments as well, specifically regarding: (1)) whether it
would be necessary and/or appropriate to adopt this uncapped TCC
rate prong to offset revenue deferral and/or displacement by the
Services; (2) whether this rate prong has caused, or would cause,
economic ``disruption'' to the Services (under Factor D of section
801(b)(1)); (3) whether the uncapped TCC rate prong would satisfy
Factors B and C of section 801(b)(1); and (4) whether this rate
prong improperly imports the complementary oligopoly power of sound
recording licensors. The Judges consider these issues after
addressing the issues relating to the ``seesaw'' theory.
---------------------------------------------------------------------------

The D.C. Circuit described the Shapley Value Model methodology:

The Shapley methodology is a game theory model that seeks to
assign to each market player the average marginal value that the
player contributes to the market. This methodology first determines
the costs that

[[Page 54417]]

each player should recover, then divides the ``surplus'' among the
players in proportion to the value of their contributions to the
worth of the hypothetical bargain that would be struck.

Johnson, 969 F.3d at 372. The Judges provided a consistent but more
detailed definition:

The Shapley value gives each player his average marginal
contribution to the players that precede him, where averages are
taken with respect to all potential orders of the players. The
Shapley value approach models bargaining processes in a free market
by considering all the ways each party to a bargain would add value
by agreeing to the bargain and then assigns to each party their
average contribution to the cooperative bargain. The idea of the
Shapley value is that each party should pay according to its average
contribution to cost or be paid according to its average
contribution to value. It embodies a notion of fairness. The Shapley
model is a game theory model that is ultimately designed to model
the outcome in a hypothetical `fair' market environment. It is
closely aligned to bargaining models, when all bargainers are on an
equal footing in the process.

Determination at 62-63 (cleaned up).
To apply a Shapley Value Model in a rate proceeding, the economic
modeler must obtain usable cost and revenue data to be inputted into
the model. More particularly for this proceeding, the modeler must
identify the parties' input costs, including the Services' non-content
costs, and the revenue derived from interactive streaming.\52\ The
difference between these revenues and the Services' noncontent costs
represents the Shapley ``surplus'' that can be shared among the
Services, the sound recording companies and Copyright Owners.
---------------------------------------------------------------------------

\52\ Identifying useful data is a vexing problem. As one of
Copyright Owners' expert economic witnesses, Professor Watt, has
written: ``[T]he main problem with the Shapley approach . . . a
particularly pressing problem [is] that of data availability.'' R.
Watt, Fair Copyright Remuneration: The Case of Music Radio, 7 Rev.
Econ. Rsch Copyright. Issues at 21, 27 (2010).
---------------------------------------------------------------------------

(i) The Shapley Approach of the Parties' Economic Expert Witnesses
(a) Professor Gans's ``Shapley-Inspired'' Model
Professor Gans, Copyright Owners' expert, utilized royalty and
profit interactive streaming data for record companies and music
publishers that he obtained from ``a [then] recent music industry
equity analysis report,'' namely, a Goldman, Sachs Equity Research
report dated October 4, 2016 entitled ``Music in the Air, Stairway to
Heaven.'' Gans WDT ] 76 & n.39. As the Majority summarized Professor
Gans's approach, ``[h]e found that, for the music publishers to recover
their costs and achieve profits commensurate with those of the record
companies under his approach, the ratio of sound recording royalties to
musical works royalties derived from his Shapley-inspired analysis was
[REDACTED] (which attributes equal profits to both classes of rights
holders and acknowledges the higher costs incurred by record companies
compared to music publishers).'' Determination at 69 (citing Gans WDT ]
77 tbl.3) (emphasis added).
Regarding Professor Gans's Shapley-inspired analysis, the Majority
stated:

[T]he Judges find the ratio of sound recording to musical work
royalties that Professor Gans derived from his analysis to be
informative. Professor Gans computed this ratio based on an
assumption of equal Shapley values between musical works and sound
recording copyright owners. The Judges find this assumption to be
reasonable . . . . [53]
---------------------------------------------------------------------------

\53\ The assumption of equal Shapley values is based on the
understanding that a sound recording license and a musical works
license are both necessary (i.e., perfect complements) in order for
a service to stream a song. Determination at 69 & n.122 therein.

Determination at 70. This is part and parcel of the ``line-drawing''
undertaken by the Majority that the D.C. Circuit affirmed. Thus, on
remand, the Judges do not find cause to reconsider the Majority's
limited adoption of Professor Gans's Shapley-inspired analysis.\54\
---------------------------------------------------------------------------

\54\ Because the ratio of sound recording to musical works
royalties that Professor Gans derived from the data and other
evidence was the only portion of his testimony on which the Majority
relied, and because that reliance was affirmed by the D.C. Circuit,
the criticisms of other aspects of Professor Gans's modeling are no
longer relevant.
---------------------------------------------------------------------------

(b) Professor Marx's Shapley Value Model
Professor Marx constructed two Shapley Value Models, one of which
was relied upon by the Majority. In the model credited by the Majority,
Professor Marx assumed one collective owner of sound recording
copyrights and one collective owner of musical works. She also assumed
the presence of a single interactive service. See Determination at 64-
68. That approach yielded a total royalty obligation for sound
recordings and musical works ranging between [REDACTED]% and
[REDACTED]% of the hypothetical service's revenue. Dissent at 133.
Copyright Owners criticized Professor Marx's decision to assume in
her model only one interactive streaming service, rather than the
multiple services that actually existed. They contend that assumption
reduced the market power of the licensors in her model. According to
Copyright Owners' economic experts, Professor Marx's approach was a
misuse of the Shapley Value Model. They aver that the Shapley Value
approach is intended only to eliminate from the rate derivation the
bargaining ability of a ``Must Have'' input supplier (like the sound
recording companies and Copyright Owners) to ``hold-out'' and thus
squeeze licensees for higher royalties. By modeling every possible
``arrival ordering,'' they contend, the ``hold-out'' problem is
avoided. They further contend that Professor Marx misconstrued the
purpose of the Shapley approach by wrongly modeling market participants
in a manner that significantly reduced the actual market power of these
``Must Have'' input suppliers. Determination at 66-67.
The Majority agreed with Professor Marx. The two Judges in the
Majority found that her modeling reasonably ``attempts to eliminate a
separate factor--market power--that she asserts renders a market-based
Shapley Analysis incompatible with the objectives of Factors B and C of
section 801(b)(1).'' Id. at 68.
Although the Majority ultimately relied upon Professor Marx's
modeling in this regard, the Majority found that her data inputs were
problematic. Determination at 65. Specifically, Professor Marx relied
on 2015 data from Warner/Chappell and Warner Music Group for music
publisher sound recording company noncontent costs, respectively. The
Majority found that 2015 data was less probative than 2016 data and
understated the percentage of revenue to be paid to the two classes of
content providers. However, the Majority ultimately found only that
this one-year older data served to ``understate'' the allocation of
surplus to the upstream content providers, and thus rejected only her
lower [REDACTED]% bound for total royalties, The Majority did decide to
adopt her upper bound of [REDACTED]% value for total royalties, which
could (and ultimately did) ``constitute a lower bound for total
royalties in computing a royalty rate,'' applied by the Majority in
order to make a downward adjustment to offset the complementary
oligopoly effect of ``Must Have'' inputs. Id. at 73, 75.
(c) Professor Watt's Criticisms of and Adjustments to Professor Marx's
Shapley Modeling
Professor Richard Watt was called by Copyright Owners as a rebuttal
witness at the hearing, for the purpose of reviewing Professor Marx's
WDT. Watt WRT ] 3. He concluded that Professor Marx's Shapley Value
Model contains important methodological and data

[[Page 54418]]

flaws which, in his opinion, caused her to significantly understate the
mechanical and overall (musical works + sound recording) royalty rates
to be paid by interactive services pursuant to a proper Shapley
analysis. Id. at ] 5.
Professor Watt also criticized her Shapley Value Model for failing
to incorporate the fact that ``the different interactive streaming
companies--Spotify, Apple Music, Rhapsody/Napster, Google Play Music,
Amazon, etc.--do all compete (and rather fiercely) among themselves,
offering (perhaps perfectly) substitutable services.'' Id. at ] 25.
Even more strongly in this vein, Professor Watt relied on the following
description of the substitutability of the streaming services, inter
se:

Each [interactive streaming] service in the increasingly crowded
field is working frantically to overcome the perception that the
main distinction among the uniformly priced $9.99 a month offering
is little more than font style, quirky playlist title and color
scheme. . . . [M]usic platforms have long fought against the
perception that they're . . . selling a nearly interchangeable
product . . . You're getting sold the same car [with] just got a
different lick of paint on it.'').

Id. at ] 32 n.19.
Professor Watt claimed that incorporating this downstream
competition into the model would reduce the Shapley values of the
Services and increase the Shapley values for the input suppliers, by
recognizing which players provide ``essential inputs'' and which are in
competition with other suppliers of substitutable inputs. Id.
He further criticized Professor Marx for including in her model
``other distributors'' who are not interactive streaming services. Id.
at ] 27. According to Professor Watt, these other distributors ``do not
belong in a properly constructed Shapley Value Model because their
presence would ``show up'' in the model as lower revenues for
interactive services as their subscribers or listeners left for these
other distributors (such as noninteractive services). Id.
Additionally, because he criticized Professor Marx's use of 2015
data (as noted supra), Professor Watt re-worked Professor Marx's model
by examining how the use of 2016 data, as opposed to her 2015 data,
would ``better reflect[ ] . . . the reality of the market. Id. at ] 37;
see also id. at ] 44. When using the (higher) 2016 revenues (and making
some relatively more minor adjustments he found necessary), Professor
Watt estimated that the share of streaming revenues that would be paid
out in total royalties (for musical works + sound recordings) in
Professor Marx's model would range from [REDACTED]% to [REDACTED]%. Id.
at ]] 50-52.\55\
---------------------------------------------------------------------------

\55\ As noted supra, when the Majority weighed and credited
Professor Watt's entire Shapley analysis, in which his estimate of
total royalties was [REDACTED]%, those Judges contextualized
Professor Marx's [REDACTED]% total royalty calculation as the lower
bound of a zone of reasonable rates, and applied it as a measure
that, in their analysis, would offset the complementary oligopoly
effect of real-world royalties. Determination at 75 (text and tbl.).
---------------------------------------------------------------------------

After analyzing these Shapley analyses,\56\ the Majority found that
the mechanical royalty rate needed to be increased in order to provide
Copyright Owners with a reasonable rate as required by section
801(b)(1). As a matter of arithmetic though, if the mechanical rate
increased and the sound recording rate did not decrease by a
corresponding amount, then the total royalties paid by the Services
would increase. That issue brings the Judges to consideration of
Professor Watt's bargaining model, on which the Majority relied to
posit an inverse relationship (the seesaw effect), by which an increase
in the mechanical rate would result in a commensurate reduction in the
sound recording rate.
---------------------------------------------------------------------------

\56\ Because his testimony was made in rebuttal, leaving the
Services no procedural right to file written testimony in
opposition, the Majority gave little weight to Professor Watt's
total royalty projections and no weight to his proffered ratios of
sound recordings-to-musical works royalties. Determination at 75.
---------------------------------------------------------------------------

(ii) Professor Watt's Bargaining Model
Professor Watt's Nash Bargaining Model is the linchpin that
connects: (a) the higher mechanical royalty rates generated by the
Shapley Value results relied upon by the Majority with (b) the assumed
lower sound recording rates--a connection that the Majority found to
render ``reasonable'' and ``fair'' its uncapped TCC prong. See
Determination at 73-74 (``As to the issue of applying a TCC percentage
to a sound recording royalty rate that is artificially high as a result
of musical works rates being held artificially low through regulation,
the Judges rely on Professor Watt's insight (demonstrated by his
bargaining model) that sound recording royalty rates in the unregulated
market will decline in response to an increase in the compulsory
license rate for musical works.''). Alternately stated, Professor
Watt's bargaining model result, i.e., the seesaw effect, if
sufficiently supported in the record, is the phenomenon that would
allow the Judges on remand to apply the Shapley results by increasing
the mechanical rate, without unduly exposing the Services to the risk
of higher total royalties.
More particularly, the Majority recognized a potential problem that
those Judges would have to resolve before utilizing the Shapley Value
approach to create an uncapped TCC prong: ``This is problematic because
the sound recording rate against which the TCC rate would be applied is
inflated . . . both by . . . complementary oligopoly [market]
conditions . . . and the record companies' ability to obtain most of
the available surplus due to the music publishers' absence from the
bargaining table.'' Determination at 73.\57\ But the Majority found
that Professor Watt had provided a rationale which permitted them to
resolve the second problem:
---------------------------------------------------------------------------

\57\ The other problem the Majority needed to resolve was how to
deflate the market-based sound recording royalty rates to mitigate
the complementary oligopoly effect in those rates. Id. As discussed
supra, the Judges resolved this problem by applying the low total
royalty payment sum, [REDACTED]%, from Professor Marx's Shapley
Value Model.

As to the issue of applying a TCC percentage to a sound
recording royalty rate that is artificially high as a result of
musical works rates being held artificially low through regulation,
the Judges rely on Professor Watt's insight . . . that sound
recording royalty rates in the unregulated market will decline in
response to an increase in the compulsory license rate for musical
works. 3/27/17 Tr. 3090 (Watt) (``[T]he reason why the sound
recording rate is so very high is because the statutory rate is very
low. And if you increase the statutory rate, the bargained sound
---------------------------------------------------------------------------
recording rate will go down.'').

Determination at 73-74; see also Watt WRT ] 23 n.13 (``[I]in my
Appendix 3, I show that . . . if the musical works rate is increased to
what would be a realistically fair and reasonable rate, then the
negotiated fee for sound recordings would decrease almost dollar for
dollar . . . .''); see also id. at ] 36 (``The statutory rate for
mechanical royalties . . . is significantly below the predicted fair
rate, and the statutory rate effectively removes the musical works
rightsholders from the bargaining table with the services. Since this
leaves the sound recording rightsholders as the only remaining
essential input, bargaining theory tells us that they will successfully
obtain most of the available surplus.'').\58\
---------------------------------------------------------------------------

\58\ In full detail, Professor Watt concluded: ``[F]or every
dollar that the statutory rate for musical works undercuts a fair
and reasonable rate, the freely negotiated rate for sound recordings
will increase by an estimated [REDACTED] cents. That is, if the
musical works rate is increased to what would be a realistically
fair and reasonable rate, then the negotiated fee for sound
recordings would decrease almost dollar for dollar, with only a
minor change in the total royalty rate for all copyrights
combined.'' Id. at ] 23, n.13; see also id., appx. 3 at 12.

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

[[Page 54419]]

To repeat: This inverse relationship is what has been described as
the ``seesaw'' effect. The question in this regard on remand is whether
the record proves that the seesaw theory is valid and measurable going
forward. Alternately stated, does the record prove that Professor
Watt's bargaining model serves as the linchpin that would allow the
Judges to apply the Shapley results by increasing the mechanical rate,
without unduly exposing the Services to the risk of higher total
royalties?
To resolve this issue, the Judges examine this bargaining model
dispute in detail, as it bears on whether the uncapped TCC rate
structure can be incorporated into the statutory rate.
(a) Bargaining Model Dispute
Professor Watt utilized a general Nash Bargaining Model.\59\ In his
particular application, Professor Watt modeled the streaming services
and the labels each as a ``single unit,'' asserting (as is common in
Shapley analyses) that this single-unit modeling was done ``for
simplicity.'' Watt WRT, appx. 3 at 10. Applying this and other modeling
assumptions, Professor Watt posited: ``If there were to be no
successful deal, then each of these two bargainers [the assumed
``single'' interactive service and ``single'' label] would earn 0,
since in that case the interactive streaming service could not
operate.'' Id.
---------------------------------------------------------------------------

\59\ The Nash Bargaining Model is one type of game-theoretic
approach used by economists to model the distribution of ``gains
from trade'' between two parties ``in a manner that reflects
`fairly' the bargaining strength of the different agents. Marx WDRT
] 28 n.33 (citing A. Mas-Colell, M. Whinston, and J. Green,
Microeconomic Theory 838 (1995)). To understand the parties'
modeling dispute, it is necessary to appreciate the essential
elements of the Nash Bargaining Model, as previously summarized by
the Judges: ``In the Nash Framework [for full quotation, see eCRB
no. 27063 n.48].'' SDARS III Final Determination, 83 FR 65210, 65215
& n.32 therein (Dec. 19, 2018).
---------------------------------------------------------------------------

In his oral testimony at the hearing, Professor Watt did not opine
as to whether changes in variables other than musical works royalties
would also have an impact on the level of sound recording royalty
rates, even as higher musical works rates would otherwise place
virtually 1:1 downward pressure on the sound recording rate. However,
in his written rebuttal hearing testimony, i.e., his WRT, Professor
Watt did make varying assumptions regarding the changes in the
Services' non-content costs, by which he did change the total revenue
share for content providers. Watt WRT ]] 50-52. He concluded from this
varying replication of Professor Marx's Shapley model ``that the
results that it delivers are very dependent upon the amount of total
interactive streaming revenue and the fraction of that revenue that is
taken up by downstream non-content costs.'' Id. at ] 53 (emphasis
added).\60\
---------------------------------------------------------------------------

\60\ The Judges take note here of Professor Watt's presentment
of alternative scenarios, because, as discussed infra, the Services
and their economists accuse Professor Watt of changing his
testimony, post-remand, by limiting the scenarios in which his
``seesaw'' argument would apply in order to salvage the credibility
of his bargaining model.
---------------------------------------------------------------------------

The Services had no procedural right under part 351 of the Judges'
regulations to proffer surrebuttal written testimony from economic
witnesses to challenge Professor Watt's assertion, made for the first
time in rebuttal, of the seesaw relationship between changes in the
musical works royalty rate and the sound recording royalty rate paid by
interactive services. Moreover, the Services and their economists also
had no opportunity to weigh in on the Majority's application of same
(which was not revealed until the Judges rendered their decision). See
Johnson, 969 F.3d at 381 (``Streaming Services had no notice that they
needed to defend against and create a record addressing such a
significant, and significantly adverse, overhaul of the mechanical
license royalty scheme.'').\61\ Now though, on this remand, the
Services have been afforded the opportunity to present these
criticisms, through their expert witnesses.
---------------------------------------------------------------------------

\61\ The Services could have sought leave to file surrebuttal
testimony, and could have challenged the Majority's understanding of
Professor Watt's testimony, after the Initial Determination, by
filing a Motion for Rehearing pursuant to 37 CFR 353.1. However, a
party is not required to engage in either of these procedural
approaches, but rather may challenge the Determination on appeal, as
has occurred here.
---------------------------------------------------------------------------

(b) Professor Katz's Principal Criticism
Pandora's economic expert, Professor Michael Katz, levied several
criticisms of the bargaining model proffered by Professor Watt and
applied by the Majority. The most important problem with Professor
Watt's analysis, according to Professor Katz, is that the former's
model assumes an ``extremely unrealistic'' zero payoff to the label in
the absence of an agreement with a streaming service--an assumption
which is ``far from . . . innocuous.'' Written Direct Remand Testimony
of Professor Michael Katz (Katz WDRT) ]] 16, 20.
Professor Katz opines that this zero payoff assumption is
equivalent to assuming, contrary to undisputed market facts, that: (1)
subscribers and listeners to an interactive service would not switch to
other interactive services if that service failed to reach an agreement
with the labels; and (2) the interactive service is a ``Must-Have''
input supplier. Katz WDRT ]] 17-18. In terms of Nash modeling,
according to Professor Katz, Professor Watt's assumption is thus
equivalent to ``assum[ing] that the sound recording copyright owners
have no outside option.'' Katz WDRT ] 127 (app. A) (emphasis added).
Moreover, not only does Professor Katz assert the indisputability
that such substitution would occur, he points out that Professor Watt
himself acknowledged in his own testimony that such substitution would
occur. Katz WDRT ] 19.\62\
---------------------------------------------------------------------------

\62\ The Judges have quoted Professor Watt's testimony in this
regard supra.
---------------------------------------------------------------------------

Beyond this purported inconsistency, Professor Katz finds Professor
Watt's no-substitution assumption to be a serious modeling error
because, in order to quantify accurately each Nash bargainer's
contribution to the net surplus to be divided, the extent of
substitutability on each side of the market must be captured by the
modeling. Katz WDRT ] 20. That is, he opines that ``Professor Watt's
assumption that there is no substitution dramatically biases his model
toward finding a large seesaw effect and renders his analysis
unreliable . . . lead[ing]to a prediction that the share of an increase
in musical works royalties that will fall on the streaming services is
approximately eight times larger than Professor Watt's prediction. Id.
at ] 21.
As a matter of music business dynamics, Professor Katz interprets
Professor Watt's substitutability error as follows.

The assumption that a label receives a zero payoff if it does
not reach agreement with a streaming service is equivalent to
assuming that, if a streaming service shut down, none of the
consumers who would otherwise have used that streaming service will
switch to alternative streaming services or other sources of
licensed music. The two forms of the assumption are equivalent
because, when the services are substitutes, failure to reach an
agreement with one service will not drive a label's payoffs from
interactive streaming to zero. It will not result in the loss of all
of the benefits that could be enjoyed by reaching an agreement.
Instead, many consumers would engage in substitution and choose
other streaming services, which will allow the label to earn profits
from the additional royalties that would be paid to it by those
other services.

Id. at ] 18.
Professor Katz attempts to adjust Professor Watt's Nash Bargaining
Model to account for this substitution effect. In his Appendix A,
Professor Katz--acknowledging the reality of multiple interactive
services--changes Professor Watt's assumed single label's payoff

[[Page 54420]]

(designated as parameter ``A'' in the Nash Bargaining Model) from a
value of zero to a value equal to ``the share of revenues that would be
diverted to other streaming services'' multiplied by ``the royalty rate
that the label receives from the other interactive streaming
services.'' Id. ]] 119, 127. Professor Katz asserts that the diversion
to other streaming services represents an ``outside option'' available
to a label. Id. ] 127. Professor Katz incorporates this ``outside
option'' in his revised version of Professor Watt's Nash Bargaining
Model.
In addition, Professor Katz asserts that Professor Watt's modeling
is unreliable because ``his prediction of the size of the see-saw
effect is very sensitive to the assumed values of various other
parameters.'' Id. at ] 23. For example, Professor Katz asserts that a
change in the royalty rate paid to the labels could materially affect
the balance or even the existence of the seesaw effect. Id. at ] 127.
As further support for his opinion, Professor Katz relies on the
testimony of one of Copyright Owners' own economic expert witnesses,
who gave testimony clearly indicating that the ``seesaw'' effect was
not at all likely to occur. Id. ] 24, n.16 (citing Gans WRT ] 32).\63\
---------------------------------------------------------------------------

\63\ In this regard, Professor Gans testified: ``[When
considering] the general distribution of profit when royalty rates
for musical works rightsholders are increased[,] [i]n principle,
those funds could come from a decrease in service profit, a decrease
in sound recording royalties, or an increase in consumer pricing . .
. . The general redistribution of profit in response to increased
musical works royalties is fundamentally an empirical question. . .
.'' Gans WRT ] 32.
---------------------------------------------------------------------------

In sum, Professor Katz finds Professor Watt's Nash Bargaining Model
to be unusable as a foundation to set royalty rates because, although
``there are theoretical reasons to believe that a see-saw effect may
occur, . . . there are complications and it is difficult to predict how
big the effect will be.'' Id. ] 24 (emphasis added).
(c) Professor Watt's Rebuttal to Professor Katz
In rebuttal to Professor Katz's criticisms, Professor Watt states
that ``the record needs to be straight on Nash bargaining theory,'' in
order to explain ``the foundational error'' committed by Professor
Katz. Watt RWRT ] 52. This basic mistake, according to Professor Watt,
is Professor Katz's erroneous assertion that the bargaining model must
account for a label's ``outside option.'' Id. ] 53. Relying on economic
authority regarding bargaining theory, Professor Watt defines an
``outside option'' as ``the best alternative that a player can command
if he withdraws unilaterally from the bargaining process.'' Id. ] 59
(emphasis added); see also id. ] 53 (``An outside option is a payoff
that the label would receive if negotiations with the service do not
result in an agreement.'') (emphasis added).\64\
---------------------------------------------------------------------------

\64\ The phrase ``outside option'' suggests the existence of an
``inside option.'' Indeed, a treatise cited by Professor Watt
identifies the ``inside option,'' defining it as ``[t]he payoff the
[bargainer] obtains while the parties temporarily disagree''--
contrasting it with the ``outside option'' as (consistent with
Professor Watt's testimony) ``the payoff [the bargainer] obtains if
she chooses to permanently stop bargaining, and chooses not to reach
an agreement with [the counterparty].'' A. Muthoo, Bargaining Theory
with Applications at 137 (1999).
---------------------------------------------------------------------------

Connecting this principle of bargaining theory to economic theory,
Professor Watt explains his understanding of the relationship of the
``outside option'' to the more familiar economic concept of
``opportunity cost'':

An outside option could also be referred to as an ``opportunity
cost,'' since it is the value of what would be foregone should a
deal with the service actually be struck. It is . . . useful to
recognize the equivalence between an outside option and an
opportunity cost, because economics in general has a very long
history of understanding how opportunity costs weigh in on economic
decision making.

Id.
Professor Watt then opines how Professor Katz confused the
``outside option'' with the disagreement (a/k/a threat) point in the
Nash Bargaining Model:

[Professor] Katz claim[s] that the outside option value that the
labels would enjoy should they not reach an agreement with the
services should be included as part of the ``disagreement point''
within the bargaining model and reimbursed like a cost prior to
bargaining. Doing this can dramatically alter the results of the
model. It is also definitively not how such an option should be
modelled. [Professor] Katz [is] guilty of misunderstanding the Nash
bargaining model, and concretely, the meaning of a ``disagreement
point,'' and the way that an outside option should be brought into
the model.

Id. ] 55.
More particularly, according to Professor Watt, these outside
options/opportunity costs do not belong in a Nash Bargaining Model,
because they are ``not the types of status quo actual financial
payments that may be modelled as disagreement points.'' Id. ] 57.
Rather, he asserts that, as Professor Katz essentially acknowledged,
they are ``payoffs from substitution, [i.e.,] an option instead of the
deal, and they are not actual financial payments, but opportunity
costs. Id.
Professor Watt then explains that an outside option/opportunity
that by definition exists as an alternative to a bargain between two
parties lies outside the two parties' bargain, and is thus out-of-place
within a proper Nash Bargaining Model:

In the case at hand, if the parties never stop negotiating and
never take up substitute options, then no joint enterprise is
offered and there is no surplus to share, so each necessarily gets a
payoff equal to 0, just as I assumed in my model.
. . .
[A]gainst this backdrop, an outside option (a potential payoff
that is not directly related to a share of the surplus that is being
negotiated) . . . comes in [to the model] as a constraint upon the
set of feasible deals that could be struck, exactly as an
opportunity cost would be treated.

Id. ]] 57-58.
(d) Dr. Leonard's Criticisms of Professor Watt's Bargaining Model
According to Google's economic expert witness, Dr. Gregory Leonard,
the Majority wrongly relied on Professor Watt's bargaining model
because it is ``highly stylized'' and theoretically ``simplified'' in
ways that make it unable to predict that ``an increase in the musical
works royalty would be offset nearly dollar-for-dollar by a decrease in
the sound recording royalties (the ``seesaw effect''), thus leaving the
services virtually unaffected by the proposed increase in musical works
royalties.'' Leonard WDRT <greek-a> 8.
Pointedly, Dr. Leonard criticizes Professor Watt's bargaining model
as comprised of a ``veneer of `complexity' . . . mathematical formulas
and [a] reference to John Nash,'' adopted to provide a rationalization
for adoption of his Shapley Value modeling that would significantly
increase the mechanical royalty rate.'' Id. ] 16. These modeling
deficiencies, Dr. Leonard asserts, are not merely ``simplifying
assumptions [that] better focus on the specific question the model is
meant to address,'' but rather ``simplify away economic characteristics
. . . entirely abstract[ing] away economic characteristics . . .
central to the question at hand.'' Id. ] 18.
In particular, Dr. Leonard avers that Professor Watt's bargaining
model materially abstracts away from, inter alia: (1) the nature of
consumer demand for streaming services and competing forms of music;
(2) how services decide to enter or exit the streaming market; (3) the
nature of the oligopolistic interaction among the labels; (4) the
nature and timing of the bargaining between each label and each
service; (5)

[[Page 54421]]

the potential for ``hold-up'' \65\ by labels that perceive the services
to be in a vulnerable bargaining position due to their previous
industry-specific investments made under their assumption that the pre-
existing statutory structure would be maintained; and (6) the failure
of Professor Watt's bargaining model to grapple with the complementary
oligopoly structure of the sound recording market. Id. ]] 18, 20.
---------------------------------------------------------------------------

\65\ A hold-up problem occurs when: (1) parties to a future
transaction must make specific investments prior to the transaction
in order to prepare for it; and (2) the exact form of the optimal
transaction (e.g., how many units if any, what quality level, the
time of delivery) cannot be specified with certainty ex ante. W.
Rogerson, Contractual Solutions to the Hold-Up Problem, Rev. Econ.
Stud. 777 (1992). Here, the interactive services may need to commit
to paying for long-term investments, even though they cannot know
the level of their largest costs (content royalties) beyond a single
rate term.
---------------------------------------------------------------------------

These factors, he posited, are ``important for determining how
sound recording royalties would actually change in response to a change
in the statutory musical works royalty.'' Id. Professor Leonard
concludes that, by not modeling these factors, Professor Watt's
``prediction of a virtual dollar for dollar decrease in sound recording
royalties is unreliable as a basis for formulating policy.'' Id. ] 20.
Regarding the complementary oligopoly structure of the market and
its impact on the bargaining process, Professor Leonard emphasizes that
an important ``real-world hurdle'' assumed away by Professor Watt's
modeling of a single label entity is that ``each label would prefer to
have the other labels lower their sound recording royalties while
maintaining its own royalties at pre-existing levels . . . .'' Id. ]
21. More particularly, Dr. Leonard explains that ``even if a label were
to recognize that it is more efficient for overall sound recording
royalties to be lower, the label may not be willing to lower its
royalty rate without assurance that the other labels will do the
same,'' a result which he asserts ``is unlikely to happen absent some
form of collusive behavior.'' Id. Thus, Dr. Leonard maintains that the
existence and size of any ``seesaw''-induced decrease in sound
recording royalties remains indeterminate, and it remains ``within the
realm of theoretical possibility that the labels do not agree to any
reduction in sound recording royalties even if a reduction in overall
royalties would be economically efficient. Id.
(e) Professor Watt's Rebuttal to Dr. Leonard's Criticisms
Professor Watt replies with a spirited defense of economic modeling
in general and his economic bargaining model in particular. He begins
by pointing out that models are not supposed to be ``perfect
representations of reality [but rather] are intended to isolate what is
important, in order to expose a useful insight on some issue of
relevance.'' Watt RWRT ] 105. He adds that economic models (not merely
his bargaining model) ``do not necessarily deliver predictions of
situations that are immune to changes in variables outside the model,
but rather the results inform conclusions about the relationships
between the variables and parameters within the model, [which is] by
nature a crude representation[ ] of reality, but the lessons and
insights that they provide can be very relevant to real-world
applications.'' Id. ]] 106-07 (emphasis added).
With particular regard to his bargaining model, Professor Watt
takes issue with Dr. Leonard's assertion that in the former's model the
surplus is a ``fixed constant.'' See Watt RWRT ]] 110-111. Rather,
Professor Watt avers that his bargaining model assume[s] that when the
surplus . . . whatever value it takes . . . is to be shared, the
parties understand that the amount to be shared is, at that moment,
given.'' Id. ] 111 (emphasis added).
Turning to Dr. Leonard's critique regarding the purported
distortionary effect of Professor Watt's modeling assumption of a
single label and a single interactive service, Professor Watt responds
by acknowledging that, if he had modeled multiple labels and services
in the bargaining process, that would be ``not particularly
enlightening vis-[agrave]-vis the single bargain setting, as it will
not lead to different insights than those distilled by the
[Majority].'' Id. ] 113.\66\ Further, Professor Watt characterizes this
criticism as ``empty,'' because under either his two-player Nash model
or Dr. Leonard's posited multi-player (Nash-in-Nash) model, the labels
will not respond to a musical works royalty increase ipso facto with a
reduction in the sound recording royalty (i.e., the seesaw effect will
not occur if there is ``a change in some other variable.''). Id. ] 114.
---------------------------------------------------------------------------

\66\ Professor Watt describes Dr. Leonard's multiple
simultaneous negotiations in a bargaining model as a ``Nash-in-
Nash'' model, but the former does not explain why he concludes that
this approach ``will not lead to different insights'' than those the
Majority distilled from his two-party Nash model.
---------------------------------------------------------------------------

(f) Professor Marx's Criticisms of Professor Watt's Bargaining Model
Professor Marx criticizes Professor Watt's application of the Nash
Bargaining Model because, in her opinion, its ``precise prediction'' of
the nearly one-to-one seesaw relationship ``depends critically on the
assumptions that he makes and the numerical inputs that he uses.'' Marx
WDRT ] 33. First, criticizing his modeling assumptions, like Professor
Katz, she criticizes his decision to abstract from reality by positing
a single label and a single interactive streaming service. She opines
that his one label/one service modeling assumption ineluctably leads to
his conclusion that each of these two parties ``has a `disagreement
payoff' of zero [meaning that] each party ends up with nothing in the
absence of a deal.'' Id. ] 34. But this zero ``disagreement payoff'' is
merely a product of Professor Watt's abstraction from reality,
according to Professor Marx, because ``[i]n reality, if interactive
streaming went away, a share of the music listening that had occurred
through interactive streaming services would migrate to other forms of
music distribution, generating revenues for the label . . . meaning
that the disagreement payoff would be positive for the label). Id.
(emphasis added).\67\ Consistent with Professor Katz, she maintains
that Professor Watt himself acknowledged the presence of this
substitution effect when he testified that ``[t]he existing interactive
streaming companies do not hold an essential input, as first they
compete with the non-interactive services . . . .'' Id. ] 35, n.43
(citing Watt WRT, app. 3).
---------------------------------------------------------------------------

\67\ Professor Marx's reference to a substitution from a
shutdown interactive service to ``other forms of music
distribution'' is different from, but analytically analogous to,
Professor Katz's assertion that the shutdown of any one interactive
service would result in migration of its subscribers and other users
to the remaining interactive services. These analogous critiques are
complementary. See Marx WDRT ] 37 (``One would expect the same
decrease in the estimated see-saw effect by including a second,
competing interactive streaming service in the market instead of
just the one that Professor Watt uses. In that case, if no deal is
reached, users would migrate to an even closer substitute--a
competing interactive streaming service--resulting in an even higher
degree of profit migration and thus an even lower estimated see-saw
effect'').
---------------------------------------------------------------------------

More particularly, Professor Marx maintains, a record label's
disagreement payoff must be considered realistically ``in any
accounting of what would happen if record labels and interactive
streaming services failed to reach an Agreement . . . .'' Marx RWDT ]
35. And, she opines, when this real-world substitution effect is taken
into account, the seesaw effect that Professor Watt estimates is
reduced dramatically, because ``[t]he greater . . . the substitution
between streaming and other forms of distribution, the greater is the
revenue that the record label can capture in the event of disagreement

[[Page 54422]]

and the lower is the estimated see-saw effect.'' Id.\68\
---------------------------------------------------------------------------

\68\ In the context of the bargaining model, Professor Marx
identifies Professor Watt's choice of ``a market structure that is
completely symmetric between record labels and services not
reflective of the real world'' as forcing his model ``to attribute[
] all the . . . surplus division to . . . bargaining power . . . and
none of it to the market structure.'' Id. ] 38.
---------------------------------------------------------------------------

Professor Marx opines that modeling the bargaining process without
these real-world particulars diminishes the value of Professor Watt's
Nash model in several significant ways. First, because his model fails
to incorporate the presence of three major record labels, ``each with
substantial complementary oligopoly power,'' it fails to capture the
fact that ``each record label does not fully internalize the impact of
its rates on the viability of the industry.'' Id. ] 39. She points to
the Judges' Final Determination in Web IV, where the Judges note how
this aspect of complementary oligopoly compromises the value of a rate
as a useful benchmark. Id. ] 39 n.45 (quoting Web IV Final
Determination). More particularly, she opines that when, as here,
``there are multiple negotiations between multiple record labels and
multiple services,'' sound recording rates can be affected ``by the
order of negotiations'' among the several label:service negotiating
pairs--a factor that Professor Watt's bargaining model fails to
capture. Marx WRDRT ] 41.
Next, Professor Marx avers that Professor Watt's bargaining model
``does not explain how or over what time frame the market would move to
a new equilibrium.'' Id. ] 40. More particularly, she testifies,
because interactive services' ``agreements with record labels often
contain multi-year terms and can take many years to negotiate . . .
there may be little incentive or practical ability for both sides to
move to a new rate before the contract expires''. Id. ] 41. She takes
note that this point was established at the hearing during questioning
of Professor Watt from the bench:

JUDGE STRICKLER: What of the situation . . . that the . . . time
period for the existing agreements between the . . . labels and the
interactive streamers is such that they've already locked in a
particular rate and then we set a rate that's higher for the
mechanical to reflect the fact that the sound recording royalty
should drop, but it's locked in for a period of time? Are we running
the risk, then, of disrupting the market by having a total royalty
that's greater than what is indicated by your Shapley testimony,
simply because of the disparity of times in which the rates are . .
. implemented?
PROFESSOR WATT: That's a very fair point. And I didn't even
think of that until you've mentioned it . . . [T]he model I have
done is . . . assuming that . . . the bargained thing happens at the
same time as the--or in the same general period of time as a change
in the statutory rate. You're absolutely correct.

3/27/17 Tr. 3091-92 (Watt); see Marx WRDRT ] 42, n.46

Third, Professor Marx points out that Professor Watt's Nash model
does not attempt to capture the effects of the heterogeneous and
asymmetric distribution of information relevant to the bargain
available to each party at the time of negotiation. Id. ] 41.
Lastly, Professor Marx avers that Professor Watt's Nash Bargaining
Model fails to address, on a more general basis beyond informational
issues, other ``asymmetries among record labels and among services.''
Marx WDRT ] 41.
In sum, Professor Marx concludes that these foregoing real-world
points all preclude the Judges from relying on Professor Watt's
testimony to identify a stable relationship between changes in the
mechanical royalty rate and the sound recording royalty rate because
they all share a common defect--they ``lie outside Professor Watt's
model.'' Marx WRDT ] 41.
To be clear, Professor Marx does not criticize Professor Watt for
neglecting to include these points in his bargaining model; rather, she
acknowledges that ``[t]hese are difficult features to capture in a
tractable equilibrium model.'' Id. Indeed, she urges the Judges to
appreciate that relying on such a necessarily limited model, as the
Majority did, can have ``dramatic effects'' on the royalty rates
derived. Id. Professor Marx emphasizes that all of these inherent
modeling deficiencies are especially pernicious, if the bargaining
model is applied yet again on remand, to set specific rates over a
five-year period, when other variables will have independent effect on
royalty rates. Id.
(g) Professor Watt's Rebuttal to Professor Marx
Because Professor Marx's criticisms are of a similar nature to
Professor Katz's criticisms, Professor Watt responds to Professor Marx
as he did to Professor Katz. To summarize, Professor Watt responds to
Professor Marx's points as follows:
<bullet> Her criticism is centered on what he characterizes as her
``bogus'' argument that he supposedly had predicted almost a ``dollar
for dollar'' sound recording rate reduction in response to an increase
in the musical works rate (the seesaw effect). Watt RWRT ] 19.
Professor Watt finds this argument ``particularly disheartening,''
because Nash bargaining theory explains why the seesaw would apply to
the splitting of the surplus based on the available data, and that
``there are quite apparent reasons why available surplus may not
decrease even if the musical works rate increased, because of
simultaneous changes to other variables in the model.'' Id. ] 34
(emphasis added).
<bullet> Professor Marx implicitly contradicts her own reliance on
the complementary oligopoly power of the Major labels by modifying his
bargaining model through the insertion of a lower value for their
bargaining power. Id. ]] 19, 22-24, 26.
<bullet> Professor Marx misconstrues the purpose of his Nash model,
which was to serve ``as a reply'' to Professor Marx's direct testimony,
and ``to show bargaining insights that bore upon aspects of the case.''
Id. ] 29.
<bullet> Professor Marx, like Professor Katz, improperly includes
in her bargaining model a potential payoff for the label arising from
an ``outside option,'' i.e., from an alternative that the label can
choose only if the Nash bargaining terminates. Id. ]] 53--68.
(h) Professor Marx's Reply to Professor Watt's Criticism \69\
---------------------------------------------------------------------------

\69\ The Judges found that Professor Watt's remand testimony,
denoted as ``rebuttal,'' also provided de facto ``direct''
testimony, to which the Services could respond with supplemental
testimony and argument. Oct. 1st Order at 11-12. Professor Marx's
response in the following text was set forth in Spotify's permitted
supplemental testimony.
---------------------------------------------------------------------------

In her supplemental remand testimony, Professor Marx challenged
several of Professor Watt's criticisms contained in his remand
testimony. First, she takes issue with what he identified as two
``core'' economic principles of bargaining: (1) that all of the
available net surplus will be shared; and (2) that neither of the two
bargainers will demand a share such that more than the total net
surplus is shared. Marx WSRT ]] 7-8.
As an initial matter, she disputes the notion that these are
``core'' principles of bargaining. Id. ] 8. More particularly, she
states that, in the present case, because ``the label does not know
with exactitude the precise maximum that a service would be willing to
pay (i.e., its ``survival'' rate), and the service likewise does not
know the exact minimum that the label would be willing to accept,'' the
simple bargaining model must be expanded to address ``the potential for
delay and/or bargaining breakdown.'' Id.
As a further criticism, Professor Marx avers that ``[i]n the real
world, the negotiated royalty outcomes do not involve just two parties,
but rather a sequence of overlapping, interrelated,

[[Page 54423]]

bilateral bargains involving multiple competing services and multiple
record labels with complementary oligopoly power.'' Id. ] 12.\70\ This
complication, she opines, exacerbates the informational deficit noted
in the immediately preceding paragraph, such that negotiations within
the several pairings of labels and services ``are affected by
uncertainty and private information and . . . Professor Watt's
discussion of bargaining theory [thus] does not support any particular
real-world see-saw outcome.'' Id.
---------------------------------------------------------------------------

\70\ In like manner, Professor Marx opines that Professor
Spulber's discussion of bargaining theory is irrelevant to any
assessment of ``the complexities affecting real-world negotiations''
and the presence, vel non, of a seesaw outcome. Id. ] 13.
---------------------------------------------------------------------------

(iii) Resolution of the Bargaining Dispute
(a) Professor Watt's Nash Bargaining Model Does Not Support Adoption of
Uncapped TCC Rate
The purpose of Professor Watt's Nash Bargaining Model was to allay
the Judges' concern that increasing the mechanical rate would lead to
higher total royalties for the Services. His bargaining model was
understood by the Majority to show that such higher total royalties
would not result, because the model demonstrated the ``seesaw'' effect,
whereby the sound recording rate would fall almost dollar-for-dollar
with the increase in the mechanical rate. See Determination at 73-74
(``[T]he Judges rely on Professor Watt's insight . . . demonstrated by
his bargaining model that sound recording royalty rates in the
unregulated market will decline in response to an increase in the
compulsory license rate for musical works. . . . Professor Watt's
bargaining model predicts that the total of musical works and sound
recordings royalties would stay `almost the same' in response to an
increase in the statutory royalty.'') (emphasis added).\71\
---------------------------------------------------------------------------

\71\ Copyright Owners note the Majority's recognition that,
regardless of the rate structure, i.e., uncapped TCC or otherwise,
Professor Watt's ``insight'' from ``bargaining theory'' would still
apply. See Determination at 74, n.138. That being the case, the
Majority's first rationale for adopting an uncapped TCC rate is
undermined.
---------------------------------------------------------------------------

On the surface, the economic experts on both sides appear to be at
loggerheads regarding the existence and applicability of the seesaw
relationship. However, as discussed below, on further analysis of their
respective positions, in light of Professor Watt's remand testimony
regarding a key assumption in his bargaining model, their disagreement
narrows considerably and--in an important respect--vanishes
completely.\72\
---------------------------------------------------------------------------

\72\ This is unsurprising. The difference of opinion among
economists often lies in their assumptions, which may be left
unstated or opaque (intentionally or not). Once those assumptions
are laid upon the table, their differences often evaporate. As the
esteemed economist Fritz Machlup noted more than sixty years ago:
``The most prolific source of disagreement lies in differences of
factual assumptions. It is not customary for experts to state all
the assumptions that underlie their conclusions; it would be much
too cumbersome. But when they have reached very different
conclusions, then we are forced to go back and find out what
implicit assumptions they have made.'' F. Machlup, Why Economists
Disagree, 109 Proceedings of the American Philosophical Society 1, 3
(1965). In the modern world of more formal economic modeling as
well, the obfuscation of assumptions continues to be an important
source of dispute, according to a book written by a leading game
theorist upon which Professor Watt relies in his testimony. A.
Rubinstein, Economic Fables at 20 (2012) (``[T]he model's formal
mantle enables economists . . . to conceal from the layman the
assumptions the model uses.''); see J. Schlefer, The Assumptions
Economists Make at 29 (2012) ([S]ome assumptions made by economists
capture important insights, others are insane. All you have to do is
decide which capture insights, which are insane, and in which
situations.'')
---------------------------------------------------------------------------

To recap: In his WRT, Professor Watt stated

[W]ith an appropriately modelled bargaining analysis . . . in my
Appendix 3 . . . I show that for every dollar that the statutory
rate for musical works undercuts a fair and reasonable rate, the
freely negotiated rate for sound recordings will increase by an
estimated [REDACTED] cents.
That is, if the musical works rate is increased to what would be
a realistically fair and reasonable rate, then the negotiated fee
for sound recordings would decrease almost dollar for dollar, with
only a minor change in the total royalty rate for all copyrights
combined.

Watt WRT ] 23 & n.13. But nowhere in his WRT did he qualify this
statement by explicitly acknowledging that in his bargaining model
there are certain assumptions lurking, i.e., that his ``concrete''
analysis is subject to the ``ceteris paribus'' constraint--that all
other things are held constant (i.e., equal before and after the change
in the musical works rate) other things being equal).\73\
---------------------------------------------------------------------------

\73\ In his oral testimony, Professor Watt likewise did not
qualify his opinion by taking note of his ceteris paribus
assumption. See 3/27/17 Tr. 3026 et seq. (Watt).

It is only in his later remand testimony--after the D.C. Circuit's
remand had compelled him to confront criticism from adverse
economists--that Professor Watt expresses this assumption overtly,
making explicit the ``understanding'' that he had theretofore only
---------------------------------------------------------------------------
tacitly assumed:

In other words, a model in which only the two copyright rates
are permitted to change . . . as was the understanding in my
original model, allows the system to derive a clear relationship
between those two rates, and that relationship is that an increase
in one leads to a decrease in the other, that is, the `see-saw
effect.' But if . . . something else changes along with the musical
works rate . . . then the net effect does not predict that the
negotiated rate of the labels will decrease.''

Watt RWRT ] 35 (emphasis added).
Indeed, as noted supra, Professor Watt did give a nod to the
relaxing of his implied ceteris paribus assumption in his WRT, by
identifying varying ``scenarios'' in which he considered the impact of
potential changes in service revenues and service non-content costs,
leading to different percentages of royalties paid to content
providers. Watt WRT ]] 45-52. Professor Watt then used these several
assumptions and scenarios to opine as follows: ``The message that
should be taken from this exercise . . . is that the results . . . are
very dependent upon the amount of total interactive streaming revenue
and the fraction of that revenue that is taken up by downstream non-
content costs.'' Id. ] 53.\74\
---------------------------------------------------------------------------

\74\ Further, in his remand testimony, Professor Watt points out
that Professor Katz made clear in his testimony that he applied the
``all else equal'' assumption expressly in his own Nash bargaining
analysis at the hearing. Watt RWRT ] 20 (quoting Katz WRT ] 67).
---------------------------------------------------------------------------

Professor Spulber, on behalf of Copyright Owners, likewise
emphasizes on remand the importance of the ceteris paribus assumption
in economic modeling:

[A]long with an increase in the compulsory license rate, all
other things being equal, we would expect to see a decrease in sound
recording royalty rates.
. . .
``All other things being equal'' (ceteris paribus in Latin), is
a central principle for economic modelling. This economic analysis
of bargaining highlights an important relationship between two
content cost variables. However, that relationship does not exist in
a vacuum. Many other variables affect the bargaining situation and,
for any given period, the net effect of all of the different
variables may be different than the effect of the modeled variable
alone. Thus, this economic analysis of bargaining will not assure
that a streaming service will not face disruption in the real world
for any reason.
. . .
Economic modeling is supposed to simplify the situation in order
to distill useful principles and teachings.

Spulber RWRT ]] 26-28 (emphasis added).
The Judges agree that the ceteris paribus principle \75\ is a
fundamental

[[Page 54424]]

principle in economic analysis and modeling. Professor Watt succinctly
makes this point, quoting the Nobel laureate economist James Buchanan,
for the following proposition:
---------------------------------------------------------------------------

\75\ The phrase is often translated into English as ``all other
things equal.'' However, that is somewhat ambiguous. Equal to what?
Not to other things. Rather, every ``thing'' (i.e., every other
independent variable) whose effects are not being measured remain
``constant,'' or ``controlled,'' i.e., ``equal'' to their measure
prior to the change of the independent variable being examined. See
W. Nicholson, Microeconomic Theory: Basic Principles and Extensions
at 649 (9th ed. 2005) (defining ``ceteris paribus'' as ``[t]he
assumption that all other relevant factors are held constant when
examining the influence of one particular variable in an economic
model'').

At the heart of any analytical process lies simplification or
abstraction, the whole purpose of which is that of making problems
scientifically manageable. In the economic system we recognize, of
course, that `everything depends on everything else,' and also that
---------------------------------------------------------------------------
`everything is always changing'.

Watt RWRT ] 32 (quoting J. Buchanan, Ceteris paribus: Some Notes on
Methodology, 24 So. Econ. J. 259, 259 (1958).
However, Professor Watt does not quote another portion of Professor
Buchanan's article that makes a point that looms large in the present
proceeding, to wit, the limitations inherent in applying the necessary
ceteris paribus condition:

Real problems require the construction of models, and the skill
of the scientist is reflected in the predictive or explanatory value
of the model chosen. We simplify reality to construct these models,
but the fundamental truth of interdependence must never be
forgotten. . . . [However,] [f]ew, if any, meaningful results may be
achieved by using ceteris paribus to eliminate the study of large
numbers of variables. If such variables are closely related, they
must be studied simultaneously; there is no escape route open.

Id. at 259-60 (emphasis added); see also A. Rubinstein, Comments on
Economic Models, Economics, and Economists: Remarks on Economics Rules
by D. Rodrik, 55 J. Econ. Lit.162, 167 (2017) ``[W]hat matters to the
empirical relevance of a model is the realism of its critical
assumptions'') (emphasis added).\76\
---------------------------------------------------------------------------

\76\ The Judges note now that Professor Watt did not claim that
his bargaining model generated any predictions, but rather that it
explained the splitting of the Shapley surplus by the sound
recording and musical works copyright owners, respectively, and the
impact of that split on royalty rates, given the assumptions and the
data in his model.
---------------------------------------------------------------------------

This is not to say that Professor Watt was unaware of this caveat.
As noted supra, he recognizes the difficulty of extrapolating from a
ceteris paribus world to the real world. The present panel of Judges
likewise recognizes this. However, the Majority missed this distinction
in the Determination when it applied Professor Watt's correct but
ceteris paribus ``insight'' for a constant real-world relationship
between sound recording and musical works royalty rates. Again, not a
single economist made this improper analytical leap or proposed an
uncapped TCC rate in order to set a TCC ratio across the entire rate
term. Indeed, on careful inspection, no economist states in his or her
remand testimony that Professor Watt's bargaining model provides
economic support for the uncapped TCC rate prong.
With the foregoing testimony in mind, the Judges see particularly
relevant several additional points in Professor Watt's remand rebuttal
testimony that pertain to the appropriateness, vel non, of a TCC rate
prong. Referring to the application of his bargaining model to the
present case, Professor Watt made these crucial statements regarding
the lack of a seesaw effect that would generate decreases in sound
recording rates when the mechanical rate is increased:

[T]he actual effects one would expect to see several years later
would be based on the actual data at that time. Moreover, I would
expect many other variables to have a larger effect on the bargains
than the relatively small changes in the musical works rate. . . .
[U]nderstanding actual market outcomes requires understanding these
variables.
. . .
[A]n attempt to capture all aspects of the real world is too
complex for a simple statistical exercise involving an econometric
regression. There is no obvious data to actually use for some of the
independent variables, such as consumer demand equations, costs of
entry and exit, a measure of oligopolistic interaction, different
timings of different rate bargains, and the actual values of outside
options.

Watt WRWT ]] 6(iv), 118.\77\
---------------------------------------------------------------------------

\77\ In the language of econometrics, Professor Watt describes
this problem as the ``almost sure[ ] impossibil[ity] of
``introduce[ing] a control variable for each and every possible
aspect that could potentially impinge upon the relationship [that]
could easily lead to such a low R\2\, and/or statistically
insignificant key coefficients, as to make the regression
meaningless.'' Id. ] 118.
---------------------------------------------------------------------------

Although Professor Watt was hardly transparent in disclosing his
ceteris paribus assumption in his original testimony, it seems clear
that he always understood its presence, and that, when this assumption
was relaxed, ``the actual effects . . . several years later would be
based on the actual data at that time [and] many other variables [with]
a larger effect on the bargains than the relatively small changes in
the musical works rate.'' Id. ] 6(iv) (emphasis added).
Professor Spulber likewise opined that the absence of an explicit
statement of these assumptions in Professor Watt's testimony was
unremarkable and appropriate:

[A]ll other things being equal'. . . should be generally read
into economic modeling conclusions or predictions, whether or not
the words are repeated in each instance. Economists do not typically
repeat these words in each place where they apply, since it would
lead to constant repetition.

Spulber RWRT ] 46, n.8.
Regardless of whether economists invariably identify the existence
of implicit assumptions lurking in each other's models, Professor Watt
overlooked a cardinal rule of communication: Know your audience. Here,
his audience is comprised of three Judges, only one of whom is also an
economist.\78\ Failing to appreciate Professor Watt's implied ceteris
paribus assumption, the Majority transformed his limited (albeit
important) ``insight'' regarding the equal split of the Shapley surplus
between the two classes of rights holders--and the seesaw effect that
would have if the mechanical rate were increased when the split was
imposed--into a justification for the imposition of an uncapped TCC
rate prong over the five-year rate term. The Majority's language
reveals this point clearly:
---------------------------------------------------------------------------

\78\ The dissenting Judge (the only economist on the panel)
warned that the seesaw effect was rife with assumptions that
rendered it too speculative to be relied upon to support the
uncapped TCC rate prong. See Dissent at 7-8.

As to the issue of applying a TCC percentage to a sound
recording royalty rate that is artificially high as a result of
musical works rates being held artificially low through regulation,
the Judges rely on Professor Watt's insight . . . demonstrated by
his bargaining model that sound recording royalty rates in the
unregulated market will decline in response to an increase in the
compulsory license rate for musical works. See 3/27/17 Tr. 3090
(Watt) (``[T]he reason why the sound recording rate is so very high
is because the statutory rate is very low. And if you increase the
statutory rate, the bargained sound recording rate will go down.'')
Professor Watt's bargaining model predicts that the total of
musical works and sound recordings royalties would stay ``almost the
same'' in response to an increase in the statutory royalty. Id. at
3091.

Determination at 73-74 (emphasis added).
Making the point ever so plainly, Professor Watt now expressly
acknowledges that his `` `see-saw effect' was never really a
`prediction' '' at all! Watt RWRT ] 117. Rather, he now cautions the
present panel of Judges, that, ``to make the jump from the model to the
actual real-world effects, one cannot ignore the words that are
omnipresent in all economic modeling,

[[Page 54425]]

that predictions about causal relationships are understood to be ``all
else equal.'' Id. ] 32.
Without the benefit of these caveats regarding an extrapolation of
the ``seesaw'' theory to the real-world, and with absence of an
explicit statement of the ceteris paribus assumption, the Majority
misapplied his testimony as a basis to adopt a fixed TCC rate, based
upon data from a snapshot in time (2016) to cement that rate
relationship for the entire five-year period.\79\ The Majority
misapplied Professor Watt's correct insight from bargaining theory
regarding the use of a fixed ratio for the equal division by two ``Must
Have'' input suppliers of the Shapley surplus to set royalty rates in a
period, by using that insight incorrectly to establish a fixed ratio of
royalty rates over the rate term.\80\
---------------------------------------------------------------------------

\79\ The importance of Professor Watt's failure to make explicit
the ceteris paribus assumption in his WRT is demonstrated by his
need to make it explicit in his RWRT. But even now, rather than
acknowledge that the Majority missed the point, he claims that the
Services' are wrongly blaming the Majority for failing to understand
this assumption: ``The Services' testimony on this remand seems
primarily focused on creating a ``straw man'' argument . . .
accus[ing] the [Majority] of something that the [Majority] did not
do--that is, rely on a guarantee of a particular decrease in sound
recording royalty rates--and the Services then attack the Board's
determination by claiming that the decrease did not occur.'' Watt
RWRT ] 5. As shown supra, however, this is precisely how the
Majority interpreted Professor Watt's ``insight.'' The Judges
understand that, as a matter of tact and tactics, Copyright Owners
may be reluctant to acknowledge that the error lies in the
combination of their witness's opaque testimony and the Majority's
lack of understanding of the assumptions economists make. Copyright
Owners might prefer to cast the Majority as the victims of the
Services' incorrect accusation. But the plain language of the
Determination belies Copyright Owners' characterization as to how
the confusion arose.
\80\ The forgoing analysis as applied to the uncapped TCC rate
needs to be contrasted with the application of Professor Watt's
bargaining model to increase the percent of-revenue rate to 15.1%.
That higher rate was set by the Majority after its consideration of
the same Shapley approaches, pursuant to the Judges' combination of
inputs from Professor Gans model (his [REDACTED] round recording-to-
musical works ratio) and the Shapley Value Model of Professor Marx
that adjusted for complementary oligopoly power by establishing a
lower total royalty level ([REDACTED]%). But the difference is that
the 15.1% revenue rate was set by applying the Shapley results based
on actual and projected market data, see Gans WRT ] 38, whereas the
uniform uncapped TCC rate (26.2%) was based on the ceteris paribus
assumption that held constant the actual data regarding the
aforementioned independent variables. As explained above though,
Professors Watt and Spulber make it clear that the ``insight'' from
bargaining theory did not have implications to allow for a
``prediction'' of rates in future periods.
Thus, when the Majority engaged in its analysis and ``line-
drawing'' to apply the data and market projections relied upon by
Dr. Gans's data, the Majority was operating--to use the D.C.
Circuit's phrase--in its ``wheelhouse,'' making a finding that
withstood appeal. Johnson, supra, 969 F.3d at 385-86; see also
Determination at 69-70 (``Professor Gans utilized data from
projections in a Goldman Sachs analysis to identify the aggregate
profits of the record companies and the music publishers,
respectively. . . . The Judges also find Professor Gans's reliance
on financial analysts' projections for the respective industries to
be reasonable.'').
---------------------------------------------------------------------------

Additionally, an examination of the expert economists' testimony
reveals that their facial disagreements vanish once the necessary
assumptions are laid bare. Professor Watt and the Services' three
economists all identify the following independent variables that will
impact the relative levels of sound recording and musical works rates
paid by interactive services:
(1) the level of downstream consumer demand;
(2) entry costs;
(3) exit costs;
(4) oligopolistic interaction;
(5) the timing of sound recording agreements vis-[agrave]-vis
statutory rate setting; and
Professor Watt and the three Service economists agree with regard
to the relevancy of these six independent variables. Compare Watt RWRT
]] 6(iv), 118 (identifying all five independent variables) with Leonard
WDRT ] 18 (identifying independent variables 1-4 above); Marx WDRT ]]
4-5, 42; (identifying independent variables 1-5 above); Katz WDRT ]]
127, 134 n.115 (identifying independent variables 4 and 6 above).
Accordingly, the remand record shows a consensus as to the lack of
modeling of independent variables that would be important to estimate
an uncapped TCC royalty ratio that could be utilized by the Judges to
lock-in a ratio over the rate term.
Indeed, as noted supra, a careful reading of the remand testimony
by Copyright Owners' economists, Professors Watt and Spulber, reveals
that neither of them actually testifies that there is sufficient
theoretical and empirical evidence to support the uncapped TCC rate
prong and the 26.2% TCC rate phased in on that prong. Rather, those two
witnesses testify to something far narrower: the alleged correctness of
Professor Watt's ``seesaw'' theory as demonstrating an equal splitting
of the surplus between the two ``Must Have'' input suppliers, and the
effect of that split when all other relevant independent variable are
held constant.
In this regard, it is noteworthy that none of Copyright Owners'
several economic experts in this proceeding (Dr. Eisenach, Professor
Gans, Dr. Rysman, or Professor Watt) ever proposed an uncapped TCC rate
prong in any form, let alone within a greater-of formulation. Such a
proposal would have been improper, because, as the expert testimony
described above makes clear, the ceteris paribus assumption, reasonable
for modeling purposes to provide insight as to the surplus split, lacks
the input of the omitted variables that the experts on both sides find
relevant to the application of economic modeling in this proceeding. A
further review of Copyright Owners' economic expert witness testimony
on remand--the first time any of them had occasion to weigh-in on the
appropriateness of the uncapped TCC prong--reveals that they also have
not endorsed the uncapped TCC rate prong as a proper form of rate
setting. To be sure, they strongly endorse the insight first described
by Professor Watt in his WRT that the Nash surplus would be split
essentially evenly between the two suppliers of essential content,
given his simplifying assumptions. But such endorsement is hardly the
same as endorsement of the uncapped rate prong itself.
For these reasons, the Judges find erroneous the Majority's
identification of a fixed relationship between the sound recording and
mechanical royalty rates that could serve as a basis for the Majority's
first rationale for yoking the mechanical rate to an uncapped TCC rate
prong.
(b) The Services Have Not Rebutted Copyright Owners' Prima Facie
Showing That Professor Watt's Model Demonstrates a More Limited
``Seesaw'' Effect
The foregoing analysis and decision related to the absence of a
fixed relationship between the sound recording and mechanical royalty
rates. A separate fixed relationship--the one Professor Watt has
clarified he was demonstrating all along--is that if the Judges
increase the mechanical royalty rate, the Shapley surplus realized by
the labels will decrease almost dollar-for-dollar with the increase in
the mechanical rate. The Services' economists aver that even this
version of the seesaw is defective.
According to Professors Katz and Marx, the Nash Bargaining Model
constructed by Professor Watt is deficient because it fails to properly
characterize the ``disagreement payoff'' to the sound recording company
when it and an interactive service fail to reach an agreement. More
particularly, as explained supra, they assert that Professor Watt's
model omits the value of ``outside options'' available to the sound
recording company. This criticism relates to the issue of whether the
seesaw effect would occur as posited in Professor Watt's model. That
is, the increase in the sound recording

[[Page 54426]]

company's ``disagreement payoff'' (a/k/a ``threat point'') would lead
to a higher royalty in the Nash bargain between the sound recording
company and the interactive service than needed to generate the seesaw
effect to offset the higher mechanical royalty rate.
As the several experts' positions in this regard, discussed supra,
make clear, however, each side has a different understanding of whether
an ``outside option'' is properly included in the definition and
calculation of the ``disagreement payoff.'' On the one hand, Professors
Katz and Marx claim that the existence and value of ``outside options''
should be included in the ``disagreement payoff.'' However, they
provide no economic authority for that assertion.
By contrast, Professor Watt cites to multiple economic game theory
publications and authorities for the proposition that the presence and
value of ``outside options'' are not to be included in the
``disagreement payoff'' contained in a Nash Bargaining Model. See A.
Muthoo, Bargaining Theory with Applications at 105 (1999) (``I thus
emphasize that the outside option point does not affect the
disagreement point.''); M. Osborne & A. Rubinstein, Bargaining and
Markets at 88 (1990) (``it is definitely not appropriate to take as the
disagreement point an outside option. . . .''); K. Binmore, A.
Rubinstein & A. Wolinsky, The Nash Bargaining Solution in Economic
Modeling, 17 RAND J. Econ. 176, 185 (1986) (``An outside option is
defined to be the best alternative that a player can command if he
withdraws unilaterally from the bargaining process.'').
According to Professor Watt and these authorities, the reason for
excluding ``outside options'' from the Nash Bargaining Model is
fundamental to the nature of the model itself. In the Nash approach,
the negotiating parties are bargaining with each other only over the
surplus their deal can generate, and they are attempting to agree upon
an allocation of that surplus that exists within the bounds of their
respective ``disagreement payoffs.'' Each may have ``inside options,''
which are alternatives available to them while bargaining is ongoing
and they temporarily disagree. See Muthoo, supra, at 137. However,
``outside options'' are available to a Nash bargaining party only in
lieu of continuing the Nash bargaining with the original counterparty
if it ``withdraws'' from the Nash bargaining process. See Binmore et
al., supra. Professor Watt characterizes the distinction as follows:

[T]he Nash bargaining model [is] designed as [a] self-contained
portrayal[ ] of negotiating behavior. . . . Given a surplus to
share, the Nash model . . . provide[s] allowance for financial
payments that a party is actually receiving, only while negotiations
are ongoing, without walking away for another option, and that would
cease as a result of the deal, to be factored into modelling as a
cost in some situations.'')
. . .
[A]n outside option (a potential payoff that is not directly
related to a share of the surplus that is being negotiated) . . .
comes in as a constraint upon the set of feasible deals that could
be struck. . . .''

Watt RWRT ]] 56, 58.\81\
---------------------------------------------------------------------------

\81\ Professor Marx in fact cites several of these authorities
(for other points), without noting the distinction they make between
the appropriate inclusion of ``inside options'' and exclusion of
``outside options'' in Nash modeling. See id. ] 59.
---------------------------------------------------------------------------

The Services never sought to introduce further testimony regarding
this important dispute. This is particularly striking because the
Services filed a motion to strike certain portions of the CO Reply, or
for leave to file supplemental testimony responsive to those itemized
portions. The portions the Services identified in their motion did not
include Professor Watt's criticisms as to the inclusion of ``outside
options'' in their experts' Nash modeling. Further, after the Judges
granted the Services' motion by providing them leave to file
supplemental testimony--consistent with the designations in their
motion--the supplemental testimonies did not address this ``outside
options'' issue.
In the course of discussions among the parties and the Judges
regarding remand procedures, the Judges invited the parties to produce
witnesses for a hearing, at which one or more of the Services' economic
expert witnesses could have addressed this ``outside options'' issue.
However, the Services (and Copyright Owners) waived the opportunity to
produce witnesses at a hearing. Rather, they offered, and the Judges
agreed, that they would stand on their written testimonies and proceed
to closing arguments by counsel.
In the closing arguments, each side argued numerous points of
controversy and provided the Judges with dozens of demonstrative aids
summarizing record evidence and the parties' arguments, but none of
those arguments or demonstrative aids so much as mentioned this
``outside options'' dispute. Moreover, when the Judges inquired during
closing arguments as to whether Services' counsel would be addressing
any of the experts' ``modeling disputes,'' counsel said that they were
resting on their papers. 3/8/22 Tr. 86-87 (Closing Argument).
Similarly, when the Judges inquired of Copyright Owners' counsel
whether he would be addressing the modeling ``dust-up'' between
Professors Watt and Katz, counsel demurred, stating that although he
would ``love to engage on it but . . . ``there would be too many
slides. . . .'' Id. at 262-64.
Simply put, the Services' economic experts made an assertion
regarding the need for Professor Watt to have included ``outside
options'' in his Nash Bargaining Model, but Professor Watt presented
authority clearly stating that such inclusions would be improper. Thus,
Copyright Owners made a prima facie showing that in a Nash Bargaining
Model, the surplus generated by the streaming surpluses acquired by the
content providers would be split equally as between the sound recording
licensors and musical works licensors, and that, ceteris paribus, an
increase in the mechanical rate to provide Copyright Owners more of the
surplus (per the Shapley-based results relied on by the Majority) would
be essentially offset through a nearly 1:1 reduction in the sound
recording rate. In response to Copyright Owners' prima facie case, the
Services stood mute in response to the rebuttal argument claiming that
their experts misapprehended the Nash modeling distinctions between
``inside options'' and ``outside options.'' \82\
---------------------------------------------------------------------------

\82\ The third economic expert for the Services, Dr. Leonard,
did not utilize the ``outside option'' phraseology to describe his
critiques. Rather, he first criticized Professor Watt for assuming
the existence of a ``fixed surplus.'' Leonard WDRT ] 16. However, as
discussed supra, that assumption came from the Majority's
extrapolation from Professor Watt's hearing testimony. His explicit
statement regarding the ceteris paribus assumption makes clear that
he was not assuming a ``fixed surplus.'' Watt RWRT ]] 110-11.
(Again, the only ``fixed'' surplus was not ``assumed,'' but rather
quantified, in order to establish the Majority's percent-of-revenue
prong royalty rate of 15.1%.)
Dr. Leonard next claims that Professor Watt's assumption that
the labels would bear virtually the entirety of an increase in the
statutory rate, because they previously ``have captured almost all''
[the] surplus,'' has been contradicted by the evidence.
Specifically, he refers to the 33-month period in which the
Phonorecords III rates were effective (January 2018 through
September 2020). Leonard WDRT ] 16. However, as the Judges find in
this Determination, that 33-month period was marked by significant
uncertainty with regard to the ultimate rates and rate structure
(and the rates were being phased-in), so no findings could reliably
be made based on sound recording rate changes during that period.
The remainder of Dr. Leonard's critique concerns issues that
would make a fixed TCC ratio inappropriate over the rate term. The
Judges agree with those criticisms as previously discussed, but they
do not pertain to this narrower issue of whether the surplus
generated by interactive streaming would be split in a manner
consistent with Professor Watt's Nash Bargaining Model.
---------------------------------------------------------------------------

Accordingly, the Judges find that the Services' criticisms in this
regard are insufficient to rebut Copyright Owners' prima facie showing
that Professor Watt's Nash Bargaining Model properly

[[Page 54427]]

identified and valued the ``disagreement payoff.'' 83 84
---------------------------------------------------------------------------

\83\ To be clear, the Judges' ruling is narrow; they make no
finding beyond crediting this prima facie showing and the failure of
the Services to rebut sufficiently that showing. It might be the
case that the existence and definition of ``outside options''--and
their relationship to ``inside options''--have other implications
vis-a-vis a Nash Bargaining Model applied in the context of a rate
setting proceeding. However, the Judges may not introduce and rely
on analytical approaches not developed by the parties. See Johnson,
969 F.3d at 381 (the Judges must not ``procedurally blindside[ ]''
the parties with an ``approach . . . first presented in the
determination and not advanced by any participant.''). See generally
P. Wald, Limits on the Use of Economic Analysis in Judicial
Decisionmaking, 50 J. L. & Contemporary Problems 225, 228 (1987) (''
judicial analysis, economic or otherwise, takes place only in the
context of lawsuits between two or more parties imposes a practical
constraint on the judge's ability to use economic analysis.'').
\84\ Professor Katz also criticizes Professor Watt's assumption
that ``a label's non-content costs are proportional to licensing
revenues.'' Katz WDRT ] 22. More particularly, Professor Katz claims
that this is not ``plausible'' because ``the royalty rate does not
directly affect the sound recording copyright owners' non-content
cost.'' Id. ] 133. The effect of eliminating this assumption,
according to Professor Katz, is to reduce the seesaw effect in
Professor Watt's model of [REDACTED] slightly further away from a
1:1 ratio, to .92. Id.
In rebuttal, Professor Watt says this criticism is inconsistent
with Professor Katz's own analysis, because the latter also ``sets
the cost equal to a fraction of revenue. . . .'' Watt ] 82 n.31
(referring apparently to a comparison of Katz WDRT ] 129 with id. ]
133). Professor Watt concludes that not only does ``[Professor]
Katz's own model contain the same feature that he is critical of in
my model,'' it is also ``not a flaw in the bargaining model.'' Watt
] 82. As a substantive matter, Professor Watt defends the assumption
that non-content costs would rise with royalty income, because
``[g]reater revenue should be directly equated with a larger scale
of business'' and ``the additional royalty income would have to be
managed (i.e., distributed to those who need to be paid from it,
such as artists), implying higher administration costs.'' Id. ] 79.
The Judges find that the common use by both experts of this
assumed proportionality of a label's non-content costs to licensing
revenues alone blunts Professor Katz's criticism of Professor Watt's
modeling. Further, Professor Watt reasonably posits that higher
revenue would imply a larger scale of business with associated
general cost increases. (But the Judges do no agree that it was
reasonable for Professor Watt to assume that distribution and
administrative costs in particular would increase merely because of
an increase in royalty rates; simply paying more money, ceteris
paribus, is not self-evidently associated with an increase in
costs.)
---------------------------------------------------------------------------

b. Rejection of Second Rationale for Including Uncapped TCC Rate Prong
In the Determination, as noted supra, the Majority also justified
the adoption of the uncapped TCC rate prong because it had the effect
of ``import[ing] into the rate structure the protections that record
companies have negotiated with services to avoid the undue diminution
of revenue through the practice of revenue deferral.'' Determination at
36; see also Johnson, 369 F.3d at 372 (``By pegging the mechanical
license royalties to an uncapped total content cost prong, the Board
sought to ensure that owners of musical works copyrights were neither
undercompensated relative to sound recording rightsholders, nor harmed
by the interactive streaming services' revenue deferral strategies. . .
.'') (emphasis added).
(i) Parties' More Specific Arguments
Copyright Owners likewise argue that the uncapped TCC rate
structure should be ``adopted to provide protection against revenue
deferment and displacement in a revenue-based rate structure.'' CO
Initial Submission at 38; see also id. at 40 (describing uncapped TCC
rate prong as ``critical backstop in a revenue-based rate
structure.'').
Whereas Copyright Owners echo the Majority, the Services adopt the
reasoning of the Dissent. They argue as follows:

[A] rate structure with a capped TCC prong, like the
Phonorecords II settlement, achieves the same goal of protecting the
Copyright Owners from any potential revenue deferral through a
``structure that provides alternate rate prongs and floors, below
which the royalty revenue cannot fall,'' . . . and does so without
allowing Copyright Owners to impermissibly share in the labels'
complementary oligopoly power. . . . [T]he streaming industry has
twice concluded, after extensive negotiations, that the appropriate
way to address any concerns regarding revenue deferral is to have a
rate structure that includes a capped TCC prong. Phono I, 74 FR
4510; Phono II, 78 FR 67938.

Services' Joint Opening Brief at 62 (quoting Dissent, 84 FR 1990)
(emphasis added).
In their Reply, Copyright Owners argue that the Majority maintained
the benefits of price discrimination contained in the prior
Phonorecords II framework, but balanced that goal with added protection
against Service revenue deferral and displacement. Copyright Owners'
Reply Brief on Remand at 49 (``In adopting a rate structure with [an
uncapped] TCC for all service offerings, the [Majority] balanced its
concerns about fostering price discrimination while also protecting
against proven revenue diminution by the Services.'').
The Services, in their Reply, take note that pre-remand, Copyright
Owners had strenuously objected to any yoking of the mechanical royalty
rate to the sound recording rate, maintaining that, although the
Copyright Owners now advocate for an uncapped TCC rate to protect
against revenue displacement and diminution:

[I]n their [pre-remand] reply proposed findings, the Copyright
Owners had expressed a very different view, arguing that an uncapped
TCC prong ``does nothing to protect Copyright Owners from the
Services' revenue displacement and deferment'' [and] Copyright
Owners have not even tried to explain away their complete about-face
on this issue.

Services' Reply at 43.
(ii) Analysis and Decision Regarding Revenue Diminution or Deferral
The Judges find that the second rationale put forth to support an
uncapped TCC rate does not justify the adoption of that rate prong.
Several reasons support this finding.
First, there is insufficient evidence to show how the sound
recording companies contractually structure their own royalty rates,
which would constitute the rate base for an uncapped TCC rate for the
mechanical royalty. The sound recording royalty rate, when proffered
for use as a mechanical royalty rate base, is analogous to pegging the
value of a foreign currency to the U.S. dollar. That is no mere
benchmark. The Judges must have the benefit of sufficient record
evidence to demonstrate that the pegging (or, to use the D.C. Circuit's
word in Johnson, ``yoking'') of a statutory rate to an unregulated rate
serves the statutory purposes for the rate at issue, here, the
mechanical rate.
But Copyright Owners presented virtually no evidence regarding how
the sound recording companies structure their interactive service
royalties. Indeed, in the hearing, Dr. Eisenach acknowledged that the
``relative value of sound recording [to] musical works licenses may
depend on a variety of factors,'' but he intentionally eschewed
unnecessary ``assumptions, complexities and uncertainties associated
with theoretical debates'' as to why the particular market ratios
existed. See Determination at 44. Indeed, the Majority found fault with
Dr. Eisenach's willful ignoring of these issues, agreeing with the
Services' criticism that Dr. Eisenach's ``use of sound recording
royalties paid by interactive services embeds within his analysis the
inefficiently high rates that arise in that unregulated market through
the complementary oligopoly structure of the sound recording industry
and the Cournot Complements inefficiencies that arise in such a market.
See Determination at 47. The uncapped TCC rate advocated now by
Copyright Owners suffers from the same affliction.
The only reference to such sound recording rate formulae in
Copyright Owners' voluminous PFF after the hearing was its statement
that the effective revenue calculations in two of the Major labels'
agreements with the

[[Page 54428]]

services was based on [REDACTED]. See Copyright Owners' PFF ]] 72, 91
(cited post-remand at Copyright Owners' Motion for Reconsideration or
Clarification at 25, n.14). On remand, the Services have provided a
further summary of the types of [REDACTED]. See White WDRT ]] 6-7, 14-
15, 20, 24-26, 28-29 ([REDACTED]); Bonavia WDRT ]] 15-17 ([REDACTED]);
Mirchandani WDRT ]] 16, 21-24 ([REDACTED]). Clearly, the levels of
[REDACTED] would have to be weighed and the impact of complementary
oligopoly power would need to be identified in order to adjust the rate
prongs to account for that power. But the record is devoid of such
details.
Second, compounding this problem, because the uncapped TCC rate is
embedded in a ``greater-of'' rate structure, the labels can exploit
their complementary oligopoly power when creating the switching points
that toggle royalty payments between and among rate prongs. As the
Judges have explained previously, in declining to import a ``greater
of'' structure from the unregulated interactive market, this
structure[it] is based on ``agreements [which] were all negotiated in a
market characterized by the lack of effective competition, and that the
lack of competition would affect the structure as well as the level of
rates.'' SDARS III, 83 FR 65210, 65228 (Dec. 19, 2018) (emphasis
added). Further, the Judges held therein that the ``advantageous''
nature of a ``greater-of'' structure to sound recording licensors ``may
well represent an example of what licensors can and would obtain when
they exploit their ``must have'' status for a special competitive
advantage.'' Id.; see also Dissent at 47 (in absence of testimony
explaining how greater-of structure is consonant with effective
competition, use by licensor suggests a game of ``heads I win tails you
lose.).''
Thus, there is insufficient evidence or testimony that would permit
the Judges to make any adjustment for the complementary oligopoly power
that may be built into each prong of the sound recording royalty rate
structures.
Third, as the Services note, Copyright Owners pre-remand, opposed
the identical rate structure--consisting of a percent-of-revenue prong
and an uncapped TCC prong--before Copyright Owners were in favor of it,
post-remand.\85\ Although Copyright Owners took a 180-degree turn on
this issue, they never stated they were wrong to oppose it previously.
Indeed, the Dissent relied upon Copyright Owners' strenuous objection
to an uncapped TCC rate, quoting it verbatim:
---------------------------------------------------------------------------

\85\ When Copyright Owners opposed the concept of an uncapped
TCC rate prong in a greater-of structure, the proposed uncapped TCC
rate was Google's 15% (and its proposed percent-of-revenue rate was
10.5%). Determination at 13. But after the Majority set the uncapped
TCC rate at 26.2%--a 75% increase over the 15% TCC rate--Copyright
Owners became zealous converts to the concept of an uncapped TCC
rate proper.

Copyright Owners rightly note that they obtain no legal
protection under such a TCC prong. In making this argument regarding
displacement and deferral of revenue, Copyright Owners lay out
comprehensively all the problems inherent in an uncapped TCC prong
set in a greater of rate structure, such as adopted in the majority
opinion:
The notion that [the] TCC prong will provide protection from
revenue gaming, deferral and displacement, and other revenue prong
problems is unsupported and speculative. Relying on just the TCC to
solve those admitted problems leaves the Copyright Owners'
protection from such problems entirely outside the statute. . . .
the per-user rates in the label deals are what protects the
Copyright Owners from price-slashing by the services. What is left
unanswered . . .is . . . how can it be reasonable to ask the Judges
to set a rate that does not itself provide for a fair return . . .
but simply puts the Copyright Owner

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