Digital Rights Network

Testimony by Sam Yagan, President MetaMachine, Inc. (developer of eDonkey and Overnet) September 28, 2005: PROTECTING COPYRIGHT AND INNOVATION IN A POST-GROKSTER WORLD in which he explains his companies 'capitulation' to the RIAA and the conversion of eDonkey to a 'closed' P2P system.

In the rest of hist testimony he argues that major chilling effects on innovation in P2P have already been felt, effects which the Grokster decision will significantly accelerate. More excerpts and comments below:

Overview

MetaMachine, Inc., a New York corporation founded in 2001 develops and distributes eDonkey, which many research studies cite has having a larger user base than any other P2P application. We incorporated MetaMachine in the United States because we believed at the time, as we continue to believe to this day, that software development was, is, and should be a legal, respected, and encouraged activity in the United States. We have succeeded in developing an innovative technology and a global user base. By incorporating in the U.S., we agreed to abide by the laws of this great nation and have generally made ourselves available to government agencies, the press, and most importantly, the entertainment industry. Unlike some of my colleagues, I have reached out to the major labels and studios in hopes of finding partners to collaborate in developing an innovative new channel for licensed distribution of music and video content.

In fact, seven of the top ten major P2P software companies have chosen to locate outside of the U.S. We must all keep this geographical issue in mind when assessing the practical benefits of any proposed legislation. First, we must consider if the legislation will affect entities outside U.S. jurisdiction; second, we must consider the possible costs of pushing technology entrepreneurs offshore.

I hope America can continue to support innovation, both creative and technological, based on the free-market drivers of capitalism rather than attempting to control and guide technological innovation in a centralized manner that may unintentionally drive innovation underground and offshore. [emphasis added]

Content Industry Unwilling to Compromise

I have spent an immense amount of energy trying to acquire licensed content from the major rights holders. As noted in my preface, I also spoke at the June 2004 Cato Institute conference on file sharing and provided testimony at the December 2004 Federal Trade Commission (FTC) Workshop on P2P in support of licensing content for authorized P2P distribution. In my comments at both of these events I pleaded with content owners to engage with us in productive dialogue.

Our company also participated with nine other companies in the Distributed Computing Industry Association’s (DCIA) P2P Revenue Engine (P2PRE) project, which focused on providing a robust solution for major entertainment content rights holders to securely market their copyrighted works via a P2P distribution channel. Although we had no way of knowing whether the P2PRE would work, we embraced the opportunity to experiment with a receptive partner in the entertainment industry.

For that project, we developed technical plans and business models, not only to secure and monetize licensed content entered into P2P distribution by rights holders or their authorized agents, but also to address their greatest concern: the redistribution of unlicensed content that has been entered into the P2P environment from unprotected CDs and DVDs directly by consumers. The P2PRE project held multiple meetings with major music labels and publishers as well as movie studios, and at one point, received verbal commitments from major entertainment firms to proceed with proof-of-concept technical testing and market trials.

The firms later rescinded these approvals, however, with the private explanation that to proceed in collaboration with eDonkey on a business solution, or even to appear to be doing so, could jeopardize the case of the petitioners in the pending MGM v. Grokster litigation. [Emphasis added]

Capitulation

As reported, the music label plaintiffs have now also expanded their legal campaign against the current major P2P software developers by sending cease-and-desist letters to seven of the leading companies, including MetaMachine.

These letters threaten imminent litigation – not only against the companies, but also against their executives and directors – based on the music industry’s interpretation of the MGM v. Grokster ruling unless the firms immediately take steps to eliminate infringement. The major movie studio plaintiffs last week announced a new thirty million dollar ($30,000,000) initiative to combat infringement through technological solutions as well as their support for the music industry’s actions.

....

Many technology companies, including eDonkey, whose products can be used for infringement will simply find themselves unable to continue operations in a Post-Grokster world -- not necessarily because they would lose under the new Grokster standard, but rather because they literally cannot afford the costs of mounting a legal defense. Companies like eDonkey must face the reality that confronting unimaginably larger opponents that can outspend small, under-funded technology companies to death makes the question of “legal” or “illegal” a moot point.

Large multinational copyright aggregators have rapidly become more aggressive in threatening lawsuits alleging secondary infringement based on inducement theories. Because the question of intent is highly fact-dependent and discovery rules will afford plaintiffs wide latitude to seek probative evidence, it will be much more difficult for defendant technology companies to win an early-phase summary judgment in these cases. The small, innovative ones will no longer be able to afford to defend themselves in the face of the far greater financial resources plaintiffs can throw into the fight.

The tenor of our conversations with content owners took a turn for the worse when MetaMachine received one of the previously described cease-and-desist letters from the Recording Industry Association of America (RIAA). This threat of imminent litigation from the major music labels, coming in light of the Supreme Court’s ambiguous ruling led us to conclude that, regardless of the virtue and lawfulness of our intentions and practices and our confidence that we never intentionally induced infringing activity, we did not have the resources to endure the protracted litigation that the RIAA letter presaged.

Because we cannot afford to fight a lawsuit – even one we think we would win – we have instead prepared to convert eDonkey’s user base to an online content retailer operating in a “closed” P2P environment. I expect such a transaction to take place as soon as we can reach a settlement with the RIAA. We hope that the RIAA and other rights holders will be happy with our decision to comply with their request and will appreciate our cooperation to convert eDonkey users to a sanctioned P2P environment. [emphasis added]

The Costs: Chilling Effects, Movement of Business Offshore, Lost Potential for Content Distribution

I believe that all of the existing open P2P companies in the United States will cease operation in coming months. Instead of creating new technologies, these companies will focus their energies on imitating the well-established retail models of iTunes, Rhapsody, and the new Napster. I would hardly define that as innovation.

It’s hard to imagine future “open decentralized” P2P companies opening shop as American corporations. That will be unfortunate because some of the benefits of companies operating in the U.S. are that they are easy for entertainment rights holders to access, they can be held to the contracts they sign, and they can be made available to provide input to Congress. I predict that, unfortunately, innovation in this area will come to a halt.

Note that this poses grave dangers. Perhaps the hottest P2P company (or any technology company for that matter) of the moment is Skype, which eBay recently acquired for more than two billion dollars. Where was Skype founded? Not in the United States. That represents hundreds of millions of tax dollars that will not be collected by federal, state, and local governments. Where are the Skypes of tomorrow being founded? Your best bet is to look offshore.

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I cannot fathom how many paid downloads we could have sold on eDonkey if the record labels had granted us licenses to sell their content. Imagine if P2P developers could have converted a mere one percent (1%) of all downloads that have occurred in their applications over the last eight (8) years. If we accept the entertainment industry’s claims that tens of billions of P2P file transfers have occurred then we have missed out on hundreds of millions of transactions that could have – should have – been consummated.

Open Content Works

This is slightly off the main topic but is really interesting info.

I am not here to tell the entertainment companies how to run their businesses – indeed, I do not claim to have all the answers. But I did run a content business for three years prior to working at eDonkey. I was one of a handful of senior executives who held the title of Publisher at Barnes & Noble, Inc. As such, I was in the business of selling content and, not surprisingly, I faced many of the same challenges that the executives at the major labels and studios face today. In closing, I will share a story from my experience there – again, not because I have all the answers, but because I hope that my experience might at least illuminate the conversation we are having at this hearing.

My job at Barnes & Noble was to sell as many SparkNotes study guides – I am talking about physical, printed, books, of course – as possible. But prior to my company’s joining Barnes & Noble, we had been giving this content away for free on our website. I vividly recall a meeting on one of my very first days at Barnes & Noble when my boss – a very senior executive at B&N – suggested that we either take down the website or start charging for access to the website. His rationale – perfectly logical and reasonable – was that we could not possibly sell books in our retail stores if we were giving away the same content online. I disagreed vehemently, arguing that we should use the website to drive sales of books. I do not think I actually convinced him, but he let me make the call and we kept the website free.

Sure enough, among a customer base that absolutely knew that they could get the exact same content for free from our website, sales of the physical books beat all of our expectations. I have had countless conversations since then – with journalists, professors, friends – who have asked how it could possibly happen that people would spend money to buy what they could get online, legally, for free. Of course, the answer was that the books were a slightly different product – they offered a different type of convenience and portability than the free web content did. Dasani and Aquafina are also great examples that you can compete with “free.” Perhaps in the ultimate sign that our model worked, our biggest competitor, Cliffs Notes, recently began offering its content free on its website. Too little, too late, though, as by that time SparkNotes’ brand recognition far exceeded that of the once venerable Cliffs Notes.

The point of this story is to provide an example of extremely liberal business rules governing the use of digital content that turned out to be highly profitable to the rights holder, in this case, Barnes & Noble. When I advocate for rules that allow users to listen to an audio file quite a large number of times for free – it is not out of any “religious” belief that content should be free. I speak from experience that you can make money by giving some content away for free.