Investing In U.S. Telcoms: Piracy Liability

 |  Includes: CBB, CTL, FTR, KNOL, S, WIN
by: Robert Steele

United States telecommunications companies may have more liability for the pervasive internet piracy problem than is currently being reported (companies like CenturyLink, Inc. (NYSE:CTL), Cincinnati Bell Inc.(NYSE:CBB), Frontier Communications Corporation (NYSE:FTR)). According to Sandvine, 18.8% of North American network traffic is used for peer-to-peer file sharing. According to Envisional, all of the top 10,000 torrents (filesharing compilations) that they sampled violated copyright. They found that 35% of BitTorrent traffic is used to illegally upload and download movies (non-pornographic), 14% for television and 2.9% is used to do so with music.

Doing the math based on traffic figures supplied by Cisco (NASDAQ:CSCO), this leads to some staggering numbers of copyright violations per household in the United States.(1) If every household were participating, and if each transaction requires one upload and one download, that would mean that on average, US households illegally download 132 movies each year. In other words, every household watches a movie illegally every five days on average. If half the households are participating, this means that they watched an illegal movie every 2.5 days.

Prior to the Internet, distributing movies illegally was pretty serious stuff. How is it that this can go on unchecked? One problem is that the illegal activity is taking place within the zone of anonymity facilitated by the ISPs. Copyright holders can prosecute claims against individual internet users, but doing so is usually not cost -effective.

Perhaps a greater problem lies in the ISPs' current interpretation of their responsibilities. Parties who facilitate copyright infringement, such as by providing network facilities, over which the activity can take place, can be found liable equally with the "direct" infringer. Congress, acknowledging the potentially crushing liabilities that could jeopardize the very existence of the ISPs, included within the Digital Millennium Copyright Act in 1998 provisions that give ISPs conditional "Safe Harbors" from this third-party liability that otherwise would arise from their subscribers' copyright infringements. In order to qualify for their "Safe Harbor," the most significant thing that these ISPs (companies like Windstream Corporation (NASDAQ:WIN), Clearwire Corporation (CLWR), Knology, Inc. (NASDAQ:KNOL)) must do is to is to terminate the accounts of repeat copyright infringers. In practice, with 18.8% of North American traffic being used to distribute movies, software, games and music and with each American household consuming a movie illegally an average of every five days, it does not appear that many repeat infringers are being terminated.

If, as it appears, repeat infringers are not being appropriately disconnected then the ISPs don't have the benefit of their "Safe Harbor." This leaves ISPs open to monumental liability.

There are many proponents of file sharing. Many bloggers and "digital rights" groups regularly advocate that filesharing is somehow not distribution even though the end user has complete possession of a new copy of the product after the file is "shared." We believe that these views simply do not match current laws in the United States.

When copyright owners choose to take peer-to-peer copyright cases to court, they win. As of February 2012, most of the 30,000 such cases filed settled out of court for between $3,000 and $5,000. Two cases have been tried. Jammie Thomas received a judgment for $1.5m for distributing 24 songs and Joel Tenenbaum received a judgment for $675,000 for downloading and distributing 31 songs.

Lawsuits against ISPs based upon these theories have not started in earnest. But there is plenty of precedent. Courts have found businesses that have been involved in contributing to copyright infringement liable for damages. In Fonovisa vs. Cherry Auction, a swap meet run by Cherry Auction was held liable to Fonovisa (the copyright owner) for damages. "As the Court observed, 'it would be difficult for the infringing activity to take place in the massive quantities alleged without the support services provided by the swap meet,' including the provision of space, utilities, parking, advertising, plumbing and customers…The Ninth Circuit expressly rejected defendant's argument that the financial benefit prong of the test for finding vicarious liability could only be satisfied if the defendant earned a commission directly tied to the sale of a particular infringing item." The Fonovisa case and its spawn provide fertile ground for copyright holders that decide to look to seek redress against ISPs for infringements being perpetrated by the subscribers that are providing the ISPs' profits.

A medium sized ISP in the United States with just 1 million subscribers would have 1.2% of US broadband market share corresponding to 132 million occurrences of illegal movie distributions in a year. If a movie studio could prove that 100,000 infringements occurred on their network by repeat infringers and a judge awarded just $3,000 per infringement, a small ISP in the United States could be faced with a $300 million judgment. On the other side, if a studio proved 10,000 infringements and was awarded just $30,000 per infringement (still substantially less than the statute), that would result in a $300m judgment.

We believe that Internet Service Providers should be making their shareholders aware of these risks and disclosing the steps they are taking to maintain their Safe Harbor by reducing the number of repeat infringers that clearly exist on their networks.

(1) Cisco states that North America used an average of 9,947 Petabytes (1 million Gigabytes) a month in 2011, which would mean that 7,899 Petabytes were used to illegally use movies, 3,141 Petabytes to illegally use television shows and 650 Petabytes were used by illegal music consumption in 2011. Assume that the average movie is 700 Megabytes. If we divide 7,899 Petabytes (1 million Gigabytes) by 700 Megabytes, we get 11.2 billion movies uploaded and downloaded illegally in 2011 (infringements). If we divide 11.2 billion movie infringements by 85 million broadband subscribers in the United States, we get an average of 132 movies uploaded and downloaded per household in the United States in 2011.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am in the business of providing anti-piracy services relevant to the topic.