Questions on the MLC Tax Return and the Ghost of Jimmy Hoffa

The Mechanical Licensing Collective posted its IRS tax return for 2019 that covers the period March 5-December 31, 2019. This partial period filing is sometimes called a “stub period” of less than all of the tax year 2019. (According to the collective’s application for designation dated March 21, 2019 the corporation had been formed; the stub may be due to the formation occurring on March 5.)

There are a few loose ends that caught my eye when I skimmed the tax return. A couple of things to keep in mind: First, the Copyright Office designated the NMPA-backed entity competing to be the mechanical licensing collective on July 8, 2019 in one of the least suspenseful government rulings of the decade. That means that the corporation existed and was operating and incurring expenses at least from and after March 5, 2019 but had not been designated officially by the Register of Copyrights until July.

That designation triggered another process called the “Administrative Assessment” at the Copyright Royalty Board which got noticed on July 8, 2019. The Administrative Assessment proceeding is how the collective got funded by Spotify, Google, Apple, Amazon and the rest of the big services (and eventually all users of the compulsory license). The proceeding had to conclude before the services knew how much to pay to the collective in what appeared to be the first assessment and the “Startup Assessment” intended to cover the costs of starting up the MLC.

The first assessment period, i.e., the annual minimum fee calculation period for the 2021 Annual Assessment and the Startup Assessment, was October 1, 2019 to September 30, 2020 according to the final rule. That final rule was not issued until January 22, 2020, and presumably the money required by the assessment was paid after that–in other words, in the 2020 tax year (or even 2021 tax year), albeit for an assessment period that straddled the 2019 tax year. I’m sure there’s some reason why the assessment period couldn’t run on a calendar year basis, but I’m not smart enough to know what the reason is.

It appears that money from the services didn’t start to flow to the MLC until 2020, i.e., after the Administrative Assessment proceeding concluded even though the 2020 funds would be credited for the assessment period that began the prior October. If the payment wasn’t received until 2020, one would expect that money to show up on the 2020 tax return, not 2019. But maybe there’s some accounting magic that made the coins jump back a year.

One could argue that the use of the term “assessment” in this context clearly implies a reference to the statutory administrative assessment (including the startup costs) as determined by the Copyright Royalty Board. It seems a stretch to use the term “assessment” to refer to a loan, “interim financing,” extended terms for accounts payable or the like.

But there’s some other strangeness regarding “Program Service Revenue,” interest expense and consultant payments that are worth discussion.

Program Service Revenue: The first thing that catches the eye in the stub period tax return is line 9 showing $10,700,000 of “Program Service Revenue”.

The IRS defines Program Service Revenue as:

Program service revenue.

Program service revenue includes income earned by the organization for providing a government agency with a service, facility, or product that benefited that government agency directly rather than benefiting the public as a whole. Program service revenue also includes tuition received by a school, revenue from admissions to a concert or other performing arts event or to a museum; royalties received as author of an educational publication distributed by a commercial publisher; interest income on loans a credit union makes to its members; payments received by a section 501(c)(9) organization from participants or employers of participants for health and welfare benefits coverage; insurance premiums received by a fraternal beneficiary society; and registration fees received in connection with a meeting or convention.

The collective’s tax return has an explanatory note of what this revenue is derived from. It comes from “Assessments”.

The source of this particular “assessment” is unclear, but it seems unlikely that it is the “Administrative Assessment” if that money was paid after the ruling by the CRB in 2020. According to an MLC press release, the financial terms of the deal between the services was announced in a December 19, 2019 press release that was subsequently adopted by the CRB as is their habit–some might say rubber stamped. It’s not the entire $33,500,000 of “startup costs”, but it’s a chunk of change. The MLC press release says “Interim financing will be provided for the MLC before formal assessment collections begin in 2021” but gave no further details such as the name of the lender or terms. But as the song says, no one remembers your name.

Interest Paid

For most taxpayers, deductible interest means that the taxpayer is legally liable for that debt, both debtor and lender intend that the debt be repaid, and the debtor and lender have “a true debtor-creditor relationship.” (Interest expense to the debtor, interest income to the creditor.) There’s lots of ins and outs of deductible interest, but let’s assume that the collective’s interest expense was for a bona fide and compliant debt obligation, perhaps the “interim financing”.

Remember–the tax return is for a stub period of nine months-ish of the tax year. The interest expense on line 20 of Part IX of the return is $49,905.

In an era of historically low interest rates, $49,905 in 9 months is a chunk of change. Naturally, one would look for an outstanding loan, but there were none. One might count the $1,419,254 in accounts payable as a kind of loan, but evidently not for tax purposes.

How would a taxpayer with no loans come up with an interest expense of $49,905? The loan principal would have to have been pretty substantial. It’s possible that the loan existed during the tax filing period but was paid off before the end of tax year and after the interest was paid. Sometimes law firms and other vendors charge a late fee if bills aren’t paid in 30 days or so, but late fees are not exactly “interest” although perhaps it could be construed that way. That also may follow from the $1,419,254 in accrued accounts payable in line 17, but it’s unclear at least to me.

Runaway Costs: One message that comes across five by five from the tax returns is the astonishing administrative costs paid out for services. (Rough justice, that’s an astronomical SG&A expense of 57% not including the accounts payable.) Remember, the MLC spent $6,178,287 in operating expense for the nine months essentially to get itself designated as the statutory mechanical licensing collective, negotiate the “administrative assessment” and doing some kind of start up work. We know that it’s impossible to do anything with the Copyright Royalty Board that doesn’t cost a gazillion dollars for the privilege of the government instructing you how to live your life, so the legal fees may seem high but are not surprising.

While I’d like to believe that they spent a lot on designing and building matching and royalty accounting systems, there is no evidence that they did. Over half of those operating expenses were legal fees and a company that styles itself a branding consultancy. Plus the MLC ended the year with another $1,419,254 in accounts payable.

All of the legal fees on the tax return went to Pryor Cashman, which is the NMPA’s outside lawyers in many proceedings (such as Phonorecords III and IV). Pryor is a fine law firm and operates with the highest integrity, so this is not a knock on them by any means and don’t let anyone tell you otherwise. I personally think the lawyers were poorly managed by the client, who I suppose is theoretically the MLC. Here’s what I mean by “managed,” and I don’t mean going over bills with a green eyeshade. I have to believe that if you went to the top five big firms in Nashville (where MLC is based) and said I have $1 million to do the same work, you would have found a team who was both competent to do the work and happy for the opportunity. As a great man once said, you don’t get very far with Cadillac taste and a Chevrolet pocketbook. Songwriters can’t afford those bills.

That’s not Pryor Cashman’s fault at all–that’s the fault of whoever was managing them. The publishers may be able to pay the NMPA’s legal bills at that level in CRB proceedings, but the NMPA is not a quasi-governmental organization like the MLC. (The services have figured this out, by the way–there’s a reason that the publishers are paying to be law and motioned into the ground in the Phonorecords III remand and in Phonorecords IV. The beatings will continue until morale improves.)

Imagine if MLC had instead spent a chunk of that money on developing or licensing a claiming portal for the $424 million in black box money they are still sitting on with no end in sight? Songwriters might actually benefit instead of watching Zeno’s arrow.

Consultants: It’s not unusual for a startup to hire consultants and the collective is no different. The consultants that they hired are listed on a schedule to the tax return. Likewise the head hunters cost what they cost. We can quibble about the amounts, but these two items are for understandable and predictable work.

I’m not really sure what these other two consulting companies did, but they evidently did a whole lot of it.

There is a loose end here with Schrompson Consulting Ltd, the UK based company serving a collective that is legally mandated to operate within the borders of the United States. So who is this Schrompson?

The UK government operates a site called “Companies House” that gives you a lot of information about private limited companies (hence “Ltd.”) operating in the UK. I don’t if it’s the same company, but there is a Schrompson Consulting Limited listed with Companies House that was created on February 25, 2019–10 days before the beginning of the stub period and presumably the date that the collective’s corporation came into existence and could have had employees. Here are the listed officers of Schrompson:

I don’t know if it’s the same person or when the payment was made to Schrompson, but there is a Richard Thompson who is a senior executive of the collective. As the MLC informed the Copyright Office in its 2019 submission for designation (at p. 57), “MLC has engaged experienced consultants to assist its Operations Advisory Committee and Board of Directors in overseeing technology strategy, the RFI/RFP process and operations design. Chief among these is Richard Thompson, former CTO of Kobalt Music and currentBoard Chair of the international standard-setting organization DDEX.” That would be the RFP process that selected HFA in the second least suspenseful government action of the decade.

According to Music Business Worldwide’s reporting on November 27, 2019, Richard Thompson was hired as Chief Information Officer of the MLC but according to the MLC’s November 26 press release, “Thompson had been serving in an interim capacity for the MLC since February 2019” which Companies House says happens to be the month that Schrompson was formed.

Recall that MLC executive Richard Thompson said at the Copyright Office panel on unclaimed royalties in December 2019, “[A] lot of the time since July has been spent working very closely with the staff at HFA and ConsenSys, really starting to nail down how all of this is going to work at the, you know, lowest operational level, all of the things that we need to work out.”  (Transcript, United States Copyright Office Unclaimed Royalties Study Kickoff Symposium (Dec. 6, 2019) at 28 ln 15, referencing the July 8, 2019 designation of The MLC as the MLC.) Don’t you love consultants who have so much enthusiasm that they confound “we” with “they”?

The Administrative Assessment and the Hoffa Clause: Recall that the Copyright Royalty Judges ruled that the compulsory license users were required to bear the cost of operating the MLC in an administrative assessment in January 2020. This was for an amount far in excess of the $10,700,000 in Program Service Revenue claimed by the collective on the 2019 tax return. But the assessment was required to be paid in 2020 as far as we can tell.

That leaves a serious question of where the $10,700,000 in “assessments” came from in 2019 and also what in the world caused there to be $49k in interest with no declared loans?

Remember that the lobbyists wrote a clause into Title I of the Music Modernization Act that allows the MLC to dip into the black box if they have expenses in excess of the administrative assessment–like they would have after the MLC was designated in July 2019 but before the first assessment was paid (some time after January 2020). The clause has become known as “the Hoffa clause” in honor of Jimmy Hoffa, the late Teamsters president who was convicted of wire fraud among other things for invading the Teamster pension funds.

I asked many times for any black box invasion to be documented and certified by officers of the MLC, but those comments were substantially ignored by the Copyright Office (and certainly by the MLC) before certain personnel changes. Just sayin’.

I’m sure there’s a simple answer for this, but I’m just a country lawyer and not as smart as these city fellers.

Cats and Dogs: There’s a few other things that are adrift in the return, but of less consequence. For example, the return is filed on Form 990 which is what non-profits use for their taxes. The taxpayer is identified as “Mechanical Licensing Collective” instead of Mechanical Licensing Collective, Inc. (the name the Copyright Office used to designate the organization). That is probably fine as far as it goes, but what if after the statutory five-year review the Copyright Office does not redesignate the Mechanical Licensing Collective (the corporation) as the statutory entity styled as the “mechanical licensing collective” by Congress? Think they’ll just give up the name?

The Program Service Revenue line 2a shows $10,700,000 of revenue from Business Code 900099, which means that it comes from a business that does not have a specific code designated by the North American Industry Classification System for which there are a bunch. I’d be interested in knowing who it was that paid that $10,700,000 but who was so unique they didn’t have an NAICS code.