In its latest assault on piracy, the recording industry is pushing legislation that would extend liability for illegal file-sharing beyond individuals and renegade software-makers to firms with a less direct role in downloading, such as Internet service providers (ISPs) and computer hardware manufacturers.

Stung by court decisions limiting its efforts to curtail file sharing, the recording industry says it needs legislation that would allow it to cast a wider net in its battle against illegal downloading. Proponents of the legislation also say it would protect intellectual property and encourage artists to create new work. Wharton faculty and technology companies, however, argue that it would stifle innovation and investment in technology. “There’s no logic to this legislation,” says Wharton marketing professor Peter Fader. “It goes against a lot of court decisions and common sense.”

The Inducing Infringement of Copyrights Act of 2004, known as the Induce Act, would hold any individual or corporation liable for infringement that “intentionally aids, abets, induces or procures” copyrighted material for illegal use. Mitch Bainwol, chief executive of the Recording Industry Association of America, wrote in a letter to the Senate that “the need for the bill has never been clearer. This legislation is essential for the legitimate online entertainment services forced to compete on an unfair playing field.”

The Motion Picture Association of America argues that copyright-protected industries account for 5% of U.S. GDP and should be vigorously defended. “The Act will further protect this vital economic contributor by clarifying for the courts that those who actively encourage others to break the laws designed to protect copyrights should not escape liability for their actions,” the association says in a statement supporting the Induce Act.

Opponents of the legislation include more than 50 corporations – among them, Google, Verizon Communications, Sun Microsystems and Yahoo – along with consumer, academic and trade associations. They argue that the legislation would unfairly hold them accountable for others’ actions. “The sponsors want to go after a few bad apples but the language of the legislation captures virtually every technology and service company, including ISPs and broadband providers, in its net,” says Sarah Deutsch, associate general counsel of Verizon Communications. Under the proposed legislation, companies like Verizon could be liable for copyright infringement for merely providing Internet access to illegal file-sharers.

The Consumer Electronics Association leads the opposition. “Right now this is the biggest threat to technology in over 20 years. We just think it will open the floodgates to frivolous lawsuits, hamper investment and stifle innovation,” says Veronica O’Connell, senior director of government affairs at the Consumer Electronics Association in Washington D.C.

The proposed bill “is a real rallying point for both sides in the file-sharing debate,” says Dan Hunter, Wharton professor of legal studies. “It’s a war between these two opposing groups.”

Lining the Pockets of Legislators

Republican senator Orrin G. Hatch, an amateur songwriter and chairman of the Senate Judiciary Committee, introduced the bill, which has gone through several rewrites and is now before the Senate Judiciary Committee. The measure also has the support of Senate majority leader Bill Frist, Republican from Tennessee, as well as Democratic leaders like Patrick J. Leahy of Vermont, Hillary Rodham Clinton of New York and Barbara Boxer of California.

The bill had been scheduled for a judiciary committee mark-up but was withdrawn from the agenda after several days of negotiations between the two sides failed to reach a compromise. While the legislation could be dead this year, it may resurface in the lame duck session after the elections and is “highly likely” to reappear next year, says Jeffrey Joseph, a spokesman for the Consumer Electronics Association.

According to Fader, while the legislation has bipartisan support among a few key senators, it also has strong opposition from a broad coalition of interests, including technology firms that often support increased intellectual property protections. “It’s very unusual when you see everyone across the political spectrum not only against it, but strongly against it,” says Fader. “To be blunt, [the recording industry] is lining the pockets of enough legislators to convince them that it’s worth their while.”

The recording industry, which is the primary driver of the legislation, has turned to the “political economy” because its current business model is threatened by the rise of file sharing, adds Hunter. “It has resisted the technology because it can’t control it and doesn’t know how to monetize it.”

The Induce Act, if it becomes law, would make the providers of digital services wary of developing any product that might generate lawsuits from the recording industry, which has shown it can be aggressive in pursuing copyright infringement cases in the courts, adds Hunter. “Innovation may be bad for the content industry, but it’s almost certainly good for consumers. The stance of the industry is just to sue absolutely everybody to death. This will have a chilling effect.”

Fader suggests that the content industry has turned to the courts and now Congress to protect a business model that is changing as a result of new technology. “Imagine if the horse-and-buggy manufacturers had legal loopholes to prevent the development of the automobile. They would use it, but would society be better off?”

The recording industry might engender more sympathy if it had made a better effort to incorporate some form of digital distribution in its business model, he adds. “It has never even run an experiment. It wants to have legislators come in to help it avoid the need to ever do so.”

New Business Models Needed

One potential new model would include the use of subscription services, in which consumers can sample music for a monthly fee and download songs for a price. The recording industry has resisted this idea, says Fader, because it is vulnerable to file-sharing. “The model for the industry is to push away from downloading completely,” he adds, arguing that the industry has confused music fans by forcing them to distinguish between illegal and legal downloading, which he says can be difficult even for savvy customers.

Fader predicts that if the industry encouraged sampling, its business would grow long-term. “It would put the industry in a far better situation. It would delight the customer. People would be much more engaged in music. They would spend more time listening to music and feel affiliations with artists.” Another approach, he says, would be for consumers to pay a subscription fee to belong to a peer-to-peer network. “The fact is, the peer-to-peer genie is out of the bottle. What’s pathetic is how the industry keeps making these senseless objections instead of saying, ‘Wait a minute, let’s give this a try. Let’s come up with a business model that would make this whole thing irrelevant.'”

Fader is more sympathetic to the film industry’s objections to file-sharing. “With music, sampling is beneficial. You want to hear a song 10 times before you make a decision, whereas with movies, you see it once and it’s done.”

Joel Waldfogel, professor of business and public policy at Wharton, suggests that in the short-run, passage of the Induce Act would help record companies, which are losing revenue as a result of file-sharing. “Historically, some of the other technologies for copying did stimulate sales,” he notes. “The industry didn’t like VCRs initially, but that created a big market.” As it is now, the current digital technologies make life more difficult for the entertainment industry because consumers can get high-quality copies from the Internet that do not diminish in quality with successive copies. “If this bill were to become law it would probably reduce illegal copying at least for a while. It would benefit the content industry, but the argument that it might chill innovation in hardware products is potentially right as well.”

According to Waldfogel, the current vulnerability of the recording and film industries does not arise from a radical new innovation. “What’s different here is that instead of the new threat being a substitute technology, or some other entertainment content, it’s a complementary technology – technologies for either playing or distributing this content.”

He, too, suggests the music industry must come up with new business models. For example, the Internet could allow the industry to slash its distribution costs. “Instead of putting out CDs and shipping them on trucks, they can send them directly at a very low cost. That does suggest a very different business model than charging $15 or $20 for a CD. It might be a much more attractive way to do things. Stuff that is easy to distribute wants to be free. Given that force, I think [the recording industry] needs to come up with a new model for generating revenue.”

According to Hunter, the legislative initiative stems from several recent court decisions, particularly a federal appeals court ruling in August favoring two peer-to-peer software companies, StreamCast Networks and Grokster. The court said that a technology company should not be held liable, even if most of its users deploy it to violate a copyright. The decision was consistent with a 1984 Supreme Court decision known as the Sony-Betamax case, which protects electronics manufacturers against copyright infringement lawsuits.

“From the legalistic side, we already have theories about these sorts of liabilities which the courts have adopted pretty sensibly,” says Hunter. “If you are something like the iPod or a peer-to-peer system or an ISP, then generally speaking, contributory liability is probably not going to attach to you.”

Unintended Consequences

R. Polk Wagner, a University of Pennsylvania law professor who specializes in intellectual property, says the proposed Induce Act may be well-intentioned, but could have unintended consequences. “Even if we all understood that this is not intended to go after the iPod, let’s think about somebody creating a new product or service that’s not quite an MP3 player or something on the market now. There would be the question, ‘Am I going to run afoul of the law that is vaguely written and if the recording industry gets mad at me can it come after me?'”

Wagner generally supports the recording industry in its efforts to protect copyrights, but says the Induce Act’s intent to target technologies is troublesome. “Any time you try to lock in a legal scheme and actually define technologies and services, you are going to end up with a disaster.” He points out that the theory of extended liability has been used before, most notably in shutting down the original Napster. “Napster itself was not infringing. It was facilitating its users to engage in infringement. The company knew this was what its users were doing and the courts held it had the ability to control” that.

Gunmakers, he says, also have been challenged for being indirectly liable for crimes committed using a firearm. “A lot of people have concerns of underlying liability. The concern is it can turn into open-ended liability for a lot of companies. The decisions can get very random and may be based, not on the actual cases, but on whether people like the individuals involved or not.”

Fader points out that the Induce Act has not seen any action in the House of Representatives and is running out of time in the current session of Congress. “At this point it’s more symbolic,” something to give industry patrons a chance to say they are right, he suggests. Verizon’s Deutsch, however, remains worried that the legislation could find its way into a larger package of intellectual property bills, or be attached to some completely different, essential legislation, such as homeland security or appropriations. “The concern,” she says, is that “they might sneak this language into an appropriations bill with no floor vote, and bypass the whole legislative process.”