Archive for November, 2006

Universal Music has the Hippest Lawyers, Notwithstanding the Law of Unintended Consequences

November 21st, 2006

Last week’s viral video phenomenon featured a BofA manager who moonlights as a rock singer performed a take-off of U2’s “One” at a sales conference in which he changed the lyrics to hype the bank and its salespeople. This was noteworthy only for the fact that the singer, Mr. Ethan Chandler, is actually pretty good- until a video of the performance was posted to YouTube. Hits to the video took off and the episode culminated in Johnny Marr performing the BofA version of the song at a Modest Mouse concert in New York.

Universal Music, who has been on a tear recently in going after alleged copyright violators & scooping up revenue from every Zune player sold, promptly jumped all over the BofA homage. The piece of the story I find most amusing is that Universal’s lawyers (represented by Raul Gonzalez, Esq.) decided it was not enough merely to send private cease-and-desist letters to people hosting the site- they posted the letter in the comments under a copy of the video on

Cynical minds might ask why no similar letter had been posted under the copy on YouTube, at least until such minds are reminded that Universal now owns a piece of Google thanks to the YouTube-Google merger. In a single move, Universal gets to pound its copyright soapbox and harass a YouTube competitor. Pretty clever, except for the fact that just about no one had ever heard of Stereogum, and now they have.

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Blogging and Defamation Redux

November 21st, 2006

The California Supreme Court handed down a decision today that is great news for bloggers and all participants in online forums. In Barrett v. Rosenthal the court took up several important questions in the ongoing evolution of Section 230 of the Communications Decency Act.

Section 230 protectors users of online services from defamation liability where the users are not the authors of defamatory remarks. In the blogging context this basically means that bloggers are not liable if people leave defamatory remarks in the comments under a post.

The Barrett case is interesting because the court decided to take up a question that has been somewhat open under Section 230: whether any distinction exists between a “publisher” and a “distributor” under the law. Under common law, distributors such as news stands are viewed as more hands-off than publishers, who exercise editorial control, and distributors are given greater leeway. Section 230 specifically immunizes online publishers from liability for defamation, but doesn’t mention distributors.

The court shows just how in-touch it is with the cultural zeitgeist by saying that the publisher/distributor distinction is an artifact of the “post-Gutenberg, pre-cyberspace” world and leads to arbitrary lines drawn online. The court leaves some room for further analysis, but lays down a broad rule that anyone who creates online content that is not original, but cites to another “information service provider” is a publisher, hence immune from liability for defamation.
Put in simple terms, this means that as long as I can find someone else who voiced potentially libelous statements online, and cite to it, I can not be held liable for repeating the comments (note that the original source of the comments is still on the hook). Under this rule, nearly everyone is or can become a publisher- a remarkably Web 2.0-ey opinion.

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Mr. DMCA, meet Ms. Web 2.0

November 15th, 2006

On re-reading the Summary Judgment ruling in the LA Riots video case, I noticed another gem. The ruling describes one of the issues in the case as whether the notice and take-down remedy in the DMCA is effective. Apparently YouTube did take down the video, only to see it promptly re-posted by numerous other users.
The era of mass user-generated content was merely a gleam in the eyes of a few visionaries when the DMCA was adopted. It will be interesting to see how effective its procedures are at preserving copyright when anyone and everyone can upload their own copies of just about any material.

Inconsistencies in YouTube Copyright Policies and TechCrunch’s Big Boost to YouTube’s PR Campaign

November 15th, 2006

Youtube is struggling to plug the dike as copyrighted material pours through, as shown by its Summary Judgment motion (posted by Mark Cuban) in the LA Riots video case, and by the cease-and-desist letter sent to Michael Arrington.
Cuban and the court point out a disconnect in YouTube’s policies. In its motion YouTube claims the most obvious and seemingly best defense, that is is a service provider “conduit” under the Digital Millenium Copyright Act and falls within the SMCA’s safe harbor provisions if it promptly takes down copyrighted material on notice that unlicensed material has been posted to its site. On the other hand, YT’s Terms of Use say that users grant YT a license to use, perform, display (etc) video content when users upload the content.

It seems hard to have it both ways- either you are a conduit or a licensee. Being a licensee is well and good when users are posting home video to which they own the rights. YT thus gains the security of knowing that the users have agreed to allow YT to distribute the content for them. If the user doesn’t own the rights though, claiming a license is completely worthless. The LA Riots court even holds out the provision as evidence that YT takes on for itself the “right and ability” (emphasis added) to control infringing activity. This reasoning, if widely followed, would makes the license an actual liability.

Of course, if the user had no ability to grant a license, YT couldn’t take one. Reasonable minds could reach different conclusions as to where the license language puts YT relative to the DMCA’s safe harbor provision, which again is not a great place for YT to find itself.
Mike Arrington professed surprise that YT would take issue with a piece of software that lets YT users download videos to their hard drives. It strikes me that YouTube has no choice but to move against these kinds of activities, though. It needs to portray itself in every possible way as working within the DMCA framework. A tool that lets users make their own copies of videos effectively turns YouTube into Napster, and we all know how that story ended.

The Grokster case says that web site operators may be liable developing software “the object of promoting its use to infringe copyright, as shown by clear expression or other affirmative steps taken to foster infringement”. YouTube’s letter to TechCrunch seems designed to shift the burden of proof there by taking public steps to discourage potential copyright violation (without causing YT traffic to suffer!).
The more I think about it, the more Mike’s public response to YouTube’s letter could end up as a PR bonanza for YouTube. There may be dozens of tools for downloading video and YT may be sending letters to the authors of all of them, but in a single stroke it has managed to let hundreds of thousands of readers know that YouTube stands against anything that might facilitate copyright violations.

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Section 409A May be Delayed Ad Infinitum

November 13th, 2006

The IRS and Treasury Department last month announced that they had not yet completed final regulations for the implementation of Section 409A of the Internal Revenue Code.

To me this sounds like a bureaucratic way of saying “Congress, aren’t there enough stock option issues going on right now, and why did you saddle us with this law anyway?”

This is somewhat remarkable, to me at least, though at the same time I think it is a wise move to avoid adding even more fuel to the fire under stock options right now. I read somewhere that over 150 public companies have announced that they are auditing their past option procedures for backdating problems. Clearly many companies have reason to be concerned that the way they approved options and set prices would not stand up to outside scrutiny.

Section 409A seems well-intentioned, but unnecessarily punitive at the same time. It imposes a 20% penalty on options granted below market, and the penalty accrues not to the company but to the employee/option recipient.

Companies and their managers have suffered (sometimes deservedly) as a result of backdating issues, but under 409A many rank-and-file employees will take hits due to no fault of their own. There are certainly some senior managers who have the ability to control option pricing and should know better. Most grantees have no control over pricing, though, and assume that their employer will treat them fairly by granting options that won’t incur big tax penalties.

On the other hand, delaying implementation of the regs could make the problem worse in the end. At present, companies that move forward in good faith compliance with 409A as it is currently understood will not be penalized. This is well and good for public companies whose stock value can be readily determined on any given date. For private companies it is a completely different matter. Valuation experts do a great job with the information they have, but since no one knows exactly what the IRS is looking for (including the IRS, it seems), their work still falls into the realm of “best guess”. To date, I have not spoken with anyone able to confidently assess the value of private company shares.

In a memorable quote, stock options have been described as “the most magical wealth-creation machine the world has ever seen”. It would be disastrous throw a wrench into the machine by attaching big penalties to potentially an entire crop of early-stage options. I applaud the IRS and Treasury for taking time implementing the regs. At the same time, I hope that the procedures they ultimately put into place take proper notice of the fog in which private companies have operated over the past couple of years.

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More on CRV Model

November 10th, 2006

It doesn’t really break any new ground, but here is an interesting calculator that shows how Charles River Ventures’ QuickStart program might work.
The calculator is set up to demonstrate returns, so you can plug in different numbers for the amount of the QuickStart loan, the amounts of each subsequent fundraising round, and the exit valuation. The calculator then spits out the return to the founders and each set of investors.

This is interesting, but pretty long-term and hypothetical. I would be more interested to see a calculator that shows the effect of the QuickStart loan on a company’s cap table. E.g. how much of the company can founders preserve for themselves by using a QuickStart loan instead of a larger funding round?
I have done a million of these for my clients and thought I could try to add to the general base of knowledge here. I have no idea how to make an HTML calculator, but here is an Excel file that does the job.

The scenarios can get very complicated, but the basics could be expressed pretty simply. The main variables are:
*amount of initial loan
*amount of Series A round
*valuation at time of Series A (or percent of company sold for Series A funds)

The calculator could then spit out alternative cap tables showing founder/investor ownership percentages. One column would show ownership structure under the QuickStart model and the other would show the ownership assuming a larger VC financing. The value of the smaller, earlier financing should become readily apparent.

I made a couple of assumptions in the calculation, esp that the “VC funding” route would be for 1/2 the amount of the QuickStart Series A, and at 1/3 the valuation. Reasonable minds may disagree on the numbers, but the concept is that the target company would not need as much money in an earlier VC funding, and that the valuation at which the money comes in would be significantly lower.

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Blogging and Defamation Law

November 8th, 2006

Someone recently asked me what liability bloggers could have for libelous statements made in the comments section of blog posts. There are a couple of really good resources on the Internet here, and I am linking to them as well as describing the state of thing as I understand it generally.

Basics of Defamation Law under Common Law
First, it is important to know that libel (the written form of defamation) requires the malicious publication of untrue facts regarding a person or entity. The standard of proof is fairly high- a plaintiff needs to show that a writer made comments knowing them to be untrue and with intent to injure.

The law also holds “publishers” liable based on their ability to review and screen out defamatory material. A newspaper is the classic example of a publisher.

Mere “distributors”, on the other hand, can only be held liable if they knew or had reason to know that material was defamatory. Distributors such as news stands or book stores generally do not exercise significant editorial control over the materials they provide, and it is fair to hold them liable only if it can be shown that they participated in some active, knowing way in the dissemination of libelous material.

Bloggers are subject to this law as much as any other writer or publisher as to comments they make themselves through blog posts.

Section 230 Preempts Common Law for Electronic Publications
Bloggers are generally insulated from liability for third-party comments by statute, however. The Communications Decency Act of 1996 contains provisions that preempt the basic law expressed above in certain cases. These provisions are generally referred to as “Section 230” for their place in the Federal Code.

In particular, Section 230 says that “No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.” In the blogging context, this means that a blogger is not the publisher of content posted by third parties on a blog. Section 230 completely bars publisher liability of the blogger under defamation law.

Case law has interpreted Section 230 very broadly. A blogger could be considered either a provider of an “interactive computer service” by developing the blog space, or as a “user” of domain hosting, blog creation and internet access services provided by others. Either way, s/he is covered by Section 230.

Note as well that the comments must be left by “another information content provider”. This term has also been broadly defined and basically includes anyone other than the publisher/blogger in question. Section 230 would not apply, however, if the blogger him/herself, or a co-blogger or potentially a person in the blogger’s organization was responsible for a defamatory comment.

Distributor Liability – The Open Question
A question does exist under Section 230 whether a blogger could be held liable as a distributor of defamatory material. In other words, whether Section 230’s preemption of publisher liability also applies to liability of distributors.

If 230 applies to distributor and publisher claims, the blogger is just about completely off the hook for comments. If 230 does not apply to comments, then a plaintiff could seek to prove the elements of distributor liability described above.

Questions of fact and policy loom large here. Should it matter if the blogger screens comments before posting? Some say that screening puts the blogger on notice of the contents of comments and that distributor liability is appropriate. Others say that this policy might encourage bloggers to take a hands-off policy for comments, possibly increasing the volume of defamatory remarks, lowering the tenor of discourse and even stifling innovation in the area of screening technologies.

A case, Barrett v. Rosenthal is currently pending in the California Supreme Court on this issue. If the court decides to address the issue head on, it could become an important precedent on the distributor liability question. The court does not need to take a position, however, and may decide the case on purely factual grounds without establishing interpretive rules.

As a general matter, bloggers enjoy substantial freedom under Section 230 for liability based on third-party comments left on blog posts. Of course, no one wants to be a defendant in any kind of action, even if the outcome is clear. An modicum of care goes a long way toward avoiding defamatory information on any blog. As always, consult a lawyer if you have concerns about how the law might apply to your blog.

The Electronic Frontier Foundation has a Legal Guide for bloggers that is pretty comprehensive.
Eric Goldman is a Santa Clara University (Calif) law professor who follows developments in this area on his blog. See e.g. his blog law recap as well as periodic news updates.

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Charles River Ventures’ QuickStart model

November 1st, 2006

With all the talk about the venture model being “broken”, it is interesting to see at least one fund addressing the issue head-on. Charles River Ventures has announced something like a quick-and-easy bridge loan program with its new QuickStart plan. While the plan may be more marketing than anything else, as described below, I think it represents a significant change in the way VCs are looking at their portfolios.

The basic idea is that it costs much less to build a product than ever before. Josh Kopelman cites a figure of $500k-$1M, though in some cases I think it can be far less than that.

Given the lower costs, many companies just don’t need a $2.5M round, at least not until much later in the process. QuickStart is designed to get $250k to companies in the form of bridge loans. The investment can go forward with consent of only 2 of 5 CRV partners, so presumably the funding can happen faster as well. The net benefit, then, would be less dilution and less time spent chasing the investors, allowing entrepreneurs spend more time building a product.

On the other end of the investment, IPOs are few and far between and M&A exits command a much lower valuation than most VC firms need to generate solid IRR on $5M – $20M investments. Firms simply have too much money to invest and too few highly profitable exits to build their reputations on. QuickStart seems like a way for CRV to hedge its bets by seeding more companies earlier and seeing which ones sprout.

There are certainly problems with the QuickStart model, as pointed out by Josh and others point out.

The biggest ones are interlinked. As VC investors, CRV is expected to take an active role in the business. With numerous small investments, though, it is not clear how easy it will be to do this. Further, since CRV also intends to invest in later rounds, it may have some incentive to keep the valuation low in order to improve its conversion rate for the bridge funds.

In the end, of course, none of this is really new ground. VCs have invested in seed/bridge rounds for a long time and will continue to do so. QuickStart may be nothing more than CRV’s existing internal policies given a name and a marketing pitch. The fact that an established firm like CRV felt it needed to do it, though, speaks volumes about the current investing climate.

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Google-Youtube Strategy Insights

November 1st, 2006

Mark Cuban posts an interesting read on his blog about the multiparty negotiations required to pull off the merger. The full description is worth a read, but the essential points are here:

*Youtube had rapidly mounting copyright complaints from content owners large and small. Revenue-share offers to the major studios didn’t go far because Youtube can’t track revenue/clip very easily (to the extent it gets any).

*Once Google came on board the lanscape changed. The piece claims that Google set aside $500M of the purchase price as an escrow to deal with copyright infringement claims.

*Youtube/Google also negotiated agreements with the major studios, as has been previously described. From what I understand, the studios got shares of Google stock, so presumably the escrow funds are still intact.

*The piece also says that Youtube got a 6 month “standstill” on any claims- i.e. they have 6 months to put copyright-policing measures into place before the studios start complaining again.

*At the same time, with Youtube at least nominally “friendly” to the studios, attention turned to the other video sharing sites. Hence the actions filed shortly post-closing against Grouper and Bolt.

Cuban did a great job calling this strategy long before it emerged. He predicted the studios would target some “shallower pocket” sites in order to set precedent before going after Google/Youtube (ok, so Grouper is owned by Sony, a pretty deep pocket itself. IMO Cuban still gets full credit for calling the play, even if the details werent’ spot-on).

Given the relationship between Google and the studios now, it might not be necesary to go after them at all. The lawsuits could have the effect of putting competitive video sites out of business and cementing Youtube as the home for online video for some time to come- and the only major player the studios need to deal with.

Assuming this is all true, it is a masterful piece of work by the Google & Youtube teams. Getting the studios on board seems like the only way to justify the $1.65B price.

There is definitely a lot of risk still in the strategy, though. One reason Youtube got so big is the availability of copyrighted material. If the spigot is turned off, it seems to me that consumers will find another source. Studios could be stuck playing the same whack-a-mole game with video sites that they do with peer-to-peer music sites: as soon as one gets knoecked down another pops up.

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