Details emerge of MLC’s investment of Millions in Black Box Royalties [Chris Castle]

Troubling new details regarding Black Box funds – song royalties that remain unpaid because they can’t be associated with a specific copyright owner – and how the MLC holds them are emerging thanks to Congressional scrutiny.

by CHRIS CASTLE from Music Tech Policy

Writing in Variety during the drafting of the Music Modernization Act (especially Title I, which created the MLC), independent songwriters, composers, producers, and publishers Phil Galdston and David Wolfort wrote of the MMA:

Proponents of the [MMA] claim to have the support of the tens of thousands of music creators. [Kind of like they claimed support for frozen mechanicals.] We strongly believe that few, if any, of those writers understood the details of the bill or its implications when they were asked for support. (Indeed, the bill had not even been made public when its proponents began promoting online petitions in support, nor was its text included or a link to it provided.) And with all due respect to the songwriter organizations that were involved in the negotiations of this bill, their members do not represent the worldwide community of unpaid independent music creators for whom the MMA is supposed to be a solution.

One of those details has to do with what we now call the MLC’s “investment policy” for the black box (collected but unmatched royalties) as though it was as normal as the turning of the Earth–when it is not, as recent Questions for the Record from Chairman Darrell Issa demonstrate. 

Remember that the corpus that the MLC is investing belongs to other people and none of it belongs to the MLC. If their investment program is profitable, all the profits must be distributed and not retained by the MLC. If the program is loss making, should the ultimate payees be required to bear that loss which they had nothing to do with creating or should the MLC itself bear that loss? These are legitimate questions in any stewardship but they remain unanswered in this one.

Congress seems very interested in The MLC, Inc.’s business rules the company granted itself. The House Judiciary Committee’s Subcommittee on Courts, Intellectual Property, and the Internet (or the IP Subcommittee for short) has direct regulatory oversight over the operations of The MLC, Inc. The IP Subcommittee seems particularly interested in the MLC, Inc.’s self-appointed “investment policy.” That investment policy business rule does not appear to be founded in anything particularly concrete in the law or regulations governing the operations of the MLC, Inc. As I will explain, I think understanding this business rule is crucial to understanding the scope of the current royalty audit of the MLC by Bridgeport Music, at least potentially, and everyone else who audits the MLC.

For context, this investment policy covers the MLC’s confederates trading hundreds of millions on the open market. To give you some idea of the magnitude of the MLC’s investment of other people’s money, consider the hundreds of millions invested under its stewardship in the $1.9 billion Payton Limited Maturity Fund SI (PYLSX). 

Based on public SEC filings brought to my attention, The MLC, Inc.’s investment in this fund is sufficient to require disclosure by PYLSX as a “Control Person” that owns 25% or more of PYLSX’s $1.9 billion net asset value. PYLSX is required to disclose the MLC as a Control Person in its fundraising materials to the Securities and Exchange Commission (Form N-1A Registration Statement filed February 28, 2023). 

What is a “Control Person”? Aside from common sense, according to Rule 405 of the Securities Act, a control person has “the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.” I’m not sure this is what Congress had in mind for the MLC in Title I of the Music Modernization Act. Yet this is what we find in the Payden registration statement (at p. 57)

Unless Congress acts, the MLC gets sued, or someone audits, these various MLC business rules have the force of law with essentially no due process. Congress permits The MLC, Inc. to operate within certain very limited guidelines, particularly when it comes to The MLC, Inc.’s quasi-governmental operations involving the database and royalties, particularly unmatched royalties. So when The MLC, Inc. takes a decision or establishes a business rule involving these statutory subjects, they need to be able to point to solid statutory authority for that action where Congress allows that action. That authority will either be in Title I of the Music Modernization Act (now part of Section 115 of the Copyright Act) or regulations established by the Copyright Office. Any MLC board action or business rule on these statutory subjects not grounded in statute or regulation must give way.

Establishing guard rails for the MLC is exactly the kind of responsible approach that Congress would take. Otherwise it would look like Congress was creating a private company (nonprofit or otherwise) that would be allowed to make it up on the fly to do things through a cutout that Congress itself would not be allowed to do. Our English cousins tried that with the Honourable East India Company and that didn’t work out too well.

What has become more apparent is that in some of its business rules, Congress is concerned that The MLC, Inc. may have breached the guard rails in its short life. This “Investment Policy” is one such business rule. The MLC’s “Investment Policy” first became public to my knowledge in The MLC, Inc.’s 2021 Annual Report. The MLC, Inc.’s 2021 Annual Report refers to but does not disclose an “Investment Policy” that “covers the investment of royalty and assessment funds, respectively, and sets forth The MLC’s goals and objectives in establishing policies to implement The MLC’s investment strategy.”  (See 2021 Annual Report, Appendix at p 4.)

The MLC investment policy was a focus of the recent field hearing by the House IP Subcommitteeconducted by Chairman Issa. This is not surprising because of the vast sums of money involved, particularly the hundreds of millions in black box royalties held by the MLC. That is, the hundreds of millions of other peoples money being invested by the MLC and its confederates which has never been the subject of an upstream royalty compliance examination to my knowledge. And there is no time like the present to remedy any statutory impediments to conducting such an upstream royalty audit–if the services owed hundreds of millions, how does anyone know that the services’ effort at an account stated is in fact correct without an independent compliance exam? Fixing any impediments to justice should be one of the subjects in the imminent five-year review of the MLC’s operations by the Copyright Office or the IP Subcommittee itself.

There is a myth going around that the MMA requires, therefore authorizes, an investment program in order to pay interest at the Federal short term rate on the black box. This is a thin reed to justify investing hundreds of millions in the open market. It’s hard to believe that Congress knew the services owed hundreds of millions in unpaid and supposedly unidentified royalties but failed to establish detailed rules for stewardship of that money. It’s also hard to believe that the services didn’t know what they owed.

The MLC’s answer to Question 2 may further this misapprehension by inserting “effectively”: ”It is important to note first that the MMA effectively requires The MLC to have an investment program.” So the MMA doesn’t actually require an investment program; they deduce that requirement. Well, I deduce it does not require any such thing. I deduce the MLC should have gone back and asked for permission.

This raises more questions than it answers: Did Congress know the scale of the black box at the time the language was drafted? If not, who did (if anyone)? This is the old “What did they know and when did they know it?”

The MLC would also have you believe that it’s just impossible to go to a bank–or even multiple banks–and get insurance on the MLC’s gigantic black box or a guarantee of the Federal short term rate. If that’s true, and I don’t think it is true, it may only be true that they can’t get federal deposit insurance because it exceeds the FDIC limits. That doesn’t mean you can’t get insurance at all. Ironically, this is called the fallacy of composition. 

Having negotiated many completion bonds, I think that it’s possible to get insurance for just about any insurable risk. I also think that if you walked into pretty much any bank and said I’ve got a $700 million deposit to make and I need you to guarantee no less than the Federal short term rate and I need you to go get me an insurance policy on my deposit, I bet I would walk out with those very things. At a competitive price.

On the other hand, if I wanted to be able to trade those funds and skim the upside….who knows.

But note that the MLC did not answer the question of who gets the profit and who bears the loss. Or who pays the investment fees, for that matter. It does seem that these are relevant questions for the Bridgeport audit (and all other audits) because any losses should be made whole and any profits should be paid out, all on a prorata basis determined by any black box recovery on which profits and losses accrued. Simple, right?

It might also be appropriate for someone to question the accuracy of the MLC’s statements that there simply was no bank account available from the government or otherwise that would allow their compliance. But either way, let’s not deduce, let’s remember what the statute says:

Interest-bearing account.—Accrued royalties for unmatched works (and shares thereof) shall be maintained by the mechanical licensing collective in an interest-bearing account that earns monthly interest—

(I) at the Federal, short-term rate; and
(II) that accrues for the benefit of copyright owners entitled to payment of such accrued royalties.

It doesn’t say that the account is maintained in a bank, it says that the MLC will maintain the account and pay the interest. This sounds more like a ledger account than a bank account, particularly since the word “bank” doesn’t appear in Section 115 (the MMA). So since the statute–the mandatory “shall” language of the statute–says nothing about banks, investments, or anything like it, the entire premise of the investment program seems kind of crumbly to me. It seems like they chose to invest the hundreds of millions of black box even though the statute is not very specific about investments; some might even say silent on the issue. Which doesn’t answer the question of who knew what when, either, but certainly seems like Congress had no idea of how much money was involved and how this whole investment thingy was going to work. But then I’m just a country lawyer from Texas, what do I know.

Question 2. With regard to the MLC’s investment policy:

• Have any funds actually been invested yet by the MLC pursuant to its investment policy? If so, how much and what was the source of those funds (e.g., unmatched and unclaimed royalties, matched but unclaimed royalties, matched and claimed royalties that have not yet been distributed, assessment funds, etc.)?
• Did the MLC Board of Directors vote on the investment policy, and if so, what was the result of the vote?
• You testified that advisors recommended that certain aspects of the MLC’s investment program be kept confidential. What specific aspects did the advisors recommend be kept confidential, and what aspects were not recommended to be confidential? 
  
  How has the MLC informed its Board, its members, and the public about the non-confidential aspects of the investment policy?
  
  If the MLC invested royalty funds under its investment policy, and those investments resulted in net losses, how would the MLC address the resulting shortfall in royalty funds according to its investment policy?
  
  It is important to note first that the MMA effectively requires The MLC to have an investment program. The MLC does not engage in any sort of speculative or risky investing, but rather its program maintains the lowest risk investments available that can meet the MMA mandate to accrue interest at the federal short-term rate. What may not be apparent to many is that it is not possible to take hundreds of millions of dollars in cash to any bank – or even a variety of banks – and have a secured and insured deposit account with a guarantee of receiving interest at the federal short-term rate. The only way for The MLC to fulfill this particular statutory requirement was to create an investment program designed to meet the MMA’s directive. The MLC’s low-risk investment activities are a necessity, not a preference. There is no deposit account where The MLC can maintain royalty funds and earn interest at the federal short-term rate, without risk to the principal or interest. Since no such account was created by the MMA or made available by the government, and standard, insured bank accounts will not maintain The MLC’s cash flow with an interest guarantee that meets the MMA’s directive, The MLC developed an investment program intended to earn the necessary interest rate while keeping risk at a minimum, working with an outside financial advisory firm that has extensive experience in the field and is “fee-based,” which means the firm is paid fixed fees instead of commissions and thus has no financial interest in the ultimate investment decisions.
  
  The MLC has managed all of its funds through its investment program, and royalty funds and operational funds (as collected through the administrative assessment) are addressed separately and maintained separately. The program has investments in a handful of mutual funds managed by significant and experienced institutional investment firms that our financial advisors have thoroughly vetted. Over time, we have also held a small amount of funds in deposit accounts at a handful of commercial banks willing to offer very competitive interest rates. Funds are never placed in investments that would be classified as having heightened or high risk. The MLC’s operational funds are kept entirely separate from royalty funds and are maintained in standard business cash management accounts, which are FDIC insured, and diversified, high-grade money market funds.The MLC presented its investment program to the MLC board of directors for approval in January 2021, and after consideration and discussion with our financial advisory firm, the board approved the program.Our financial advisors have advised that we not make public any details about specific investment solutions. Their reasons include security concerns and concerns that such information could be used alongside our public royalty distribution timelines to engage in market timing to the detriment of The MLC. Public knowledge about large-scale trades can be used to exploit the market for an investment to the detriment of the known trader. Other statements in the investment policy are not confidential, including statements about the need to minimize risk, the need to act in accordance with the MMA, the intention to limit costs, and the concerns with holding funds at issue in bank accounts where funds would substantially exceed FDIC insurance.
  
  The MLC has informed the public about some non-confidential aspects of its investment policy in its Annual Report, including that the policy covers the investment of royalty and assessment funds, respectively, sets forth The MLC’s goals and objectives in establishing policies to implement The MLC’s investment strategy, and contains an anti-comingling policy (as called for by the MMA).
  
  The MLC has put great effort into crafting a cash management and investment program that minimizes risk while still meeting the MMA’s high demands. It is our intention and expectation that there will never be a shortfall. With respect to the question, “if the MLC invested royalty funds under its investment policy, and those investments resulted in net losses, how would the MLC address the resulting shortfall in royalty funds according to its investment policy?” – in the event that the situation in the hypothetical came to pass, The MLC would have to address the matter based upon the specific details at hand, but we do not pro