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Faulkner v. Arista Records LLC

United States District Court, S.D. New York

September 15, 2014

ERIC FAULKNER, DUNCAN FAURE, ALAN LONGMUIR, DEREK LONGMUIR, LESLIE MCKEOWN AND STUART WOOD, PLAINTIFFS,
v.
ARISTA RECORDS LLC, DEFENDANT

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[Copyrighted Material Omitted]

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For Eric Faulkner, Duncan Faure, Alan Longmuir, Derek Longmuir, Leslie McKeown, Stuart Wood, Plaintiffs: Robert Joseph Burns, LEAD ATTORNEY, Holland & Knight LLP, New York, NY; Joshua Krumholz, Holland & Knight, L.L.P., Boston, MA; R David Donoghue, PRO HAC VICE, Holland & Knight LLP, New York, NY; Rory E Foster, PRO HAC VICE, Holland & Knight LLP, Boston, MA.

For Gordon Clark, Pat McGlynn, Movants: William L. Buus, Schiffer & Buus APC, Newport Beach, CA; Wolfgang Heimerl, Heimerl Law Firm, Bernardsville, NJ.

For Arista Records LLC, Defendant: Nirav Sanjay Shah, LEAD ATTORNEY, Manatt, Phelps & Phillips, LLP(NYC), New York, NY; Prana A. Topper, Robert A. Jacobs, LEAD ATTORNEYS, Manatt, Phelps & Phillips, LLP(TimesSq), New York, NY.

For Ian Mitchell, Intervenor: William L. Buus, Schiffer & Buus APC, Newport Beach, CA; Wolfgang Heimerl, Heimerl Law Firm, Bernardsville, NJ.

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OPINION & ORDER

Loretta A. Preska, Chief United States District Judge.

Plaintiffs Eric Faulkner, Duncan Faure, Alan Longmuir, and Stuart Wood, former members of the Bay City Rollers, (together " Plaintiffs" or " BCR" ) brought this action alleging non-payment of tens of millions of dollars in unpaid royalties from their record company, defendant Arista Records LLC (" Defendant" or " Arista" ) pursuant to a 1981 agreement. The Complaint alleged four separate counts of breach of contract, breach of fiduciary duty, constructive trust, and an accounting. See Complaint [dkt. no. 1]. Plaintiffs requested the ability to produce experts to testify on the calculation of royalties due to the complexity of royalty accounting in the music business. [Dkt no. 176]. To help prove Plaintiffs allegations that millions of dollars of royalties were owed to them and that Arista's records could not be relied upon to calculate such royalties, Plaintiffs propose the testimony of Wayne C. Coleman. In support of its defense that Arista's records are usable, Defendant offers the rebuttal expert testimony of Tom Nilsen.

Currently before the Court are the parties' Daubert motions wherein Defendant seeks to exclude the testimony of Mr. Coleman [dkt. no. 189], a Certified Public Accountant and president of Financial Services Team, Inc. and The Royalty Compliance Organization (" RCO" ). On September 12, 2013, Defendant filed under seal its Memorandum of Law in Support of Defendant's Motion to Exclude the Expert Report of Wayne C. Coleman (" Defendant's Brief" or " Def. Br." ). On October 11, 2013 Plaintiffs filed under seal their Memorandum of Law in Opposition to Defendant's Motion to Exclude the Expert Report of Wayne C. Coleman (" Plaintiffs' Opposition" or " Pl. Opp." ). On October 30, 2013, Defendant filed under seal its Reply Memorandum of Law in Support of Defendant's Motion to Exclude the Testimony of Wayne C. Coleman (" Defendant's Reply" or " Def. Reply." ).

Plaintiffs seek to exclude the rebuttal testimony of Tom Nilsen, an accountant and partner in charge of the royalty examination group of Gelfand, Rennert & Feldman, LLP. On September 12, 2013, Plaintiffs filed under seal their Memorandum of Law in Support of Plaintiffs' Motion to Exclude the Testimony of Tom Nilsen (" Plaintiffs' Brief" or " Pl. Br." ). On October 11, 2013, Defendant filed under seal its Memorandum of Law in Opposition to Plaintiffs' Motion to Exclude the Testimony of Tom Nilsen (" Defendant's Opposition" or " Def. Opp." ). On October 30, 2013, Plaintiffs filed under seal their Reply Memorandum of Law in Support of Plaintiffs' Motion to Exclude the Testimony of Tom Nilsen (" Plaintiffs' Reply" or " Pl. Reply." ).

I. BACKGROUND

A. The Reports

1. The Expert Report of Wayne Coleman[1]

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Wayne Coleman is the founder and co-owner of Royalty Compliance Organization, a firm that provides auditing, royalty examination, valuation, expert witness, and other related services. (Declaration of Wayne C. Coleman in Support of Plaintiffs' Opposition to Defendant's Motion to Exclude the Expert Testimony of Wayne Coleman (" Coleman Decl." ) ¶ 1. He has performed or supervised thousands of examinations and testified as an expert 36 times. Coleman Decl. ¶ ¶ 4-7. Mr. Coleman initially conducted a facial review of the royalty records to determine their consistency and attempted to test the royalty records against source information such as the domestic sales data from the company's accounting system and reports from foreign sales affiliates and licensees. Coleman Rept. at 11-16; Transcript of the Deposition of Wayne C. Coleman (" Coleman Tr." ) at 66:23-67:13. Mr. Coleman analyzed Arista's royalty records for the purpose of determining their overall reliability. Coleman Tr. at 68:14-69:10, 83:19-23, 98:24-99:4, 125:23-126:14; Coleman Rept. at 4-11.

Upon a facial review of documents provided to Mr. Coleman by Arista, Mr. Coleman concludes that Arista's records are " abysmal" and failed the first test of overall reliability. Coleman Rept. at 16, 86. Mr. Coleman states that Arista's records fail his facial review for consistency, particularly because of an absence of royalty reports over extended periods of time. Id. at 4-5. Despite a provision in certain agreements that required Arista to provide semi-annual royalty accountings to Plaintiffs, Arista failed to provide such accountings over the course of several years. Id. at 3. The most extreme example is an eleven year stretch between documents concerning royalties due as of December 31, 1982 and documents concerning royalties due as of December 31, 1994. Id. at 4. Mr. Coleman indicated that the internal royalty recordkeeping of Arista does not indicate that these documents were appropriately provided to Plaintiffs. Id. at 5. This lack of royalty reporting does not mean no documents were produced by Arista during these time periods. Mr. Coleman indicated that record producers received reports during the time period and many internal reports show sales and other royalty figures. Id. at 6. In Mr. Coleman's professional opinion, these internal reports do not remedy the " information deficiency of the accounting record." Id. at 7. Mr. Coleman opines that even where royalty reports were provided, the level of detail is " generally far below minimum industry standard for valid royalty statement or account." Id. at 3.

Next, Mr. Coleman calls attention to unexplained errors in the documents which casts doubt on the reliability of Arista's accounting records. Id. at 3-4. Specifically, he identified the following inconsistencies and concerns:

o The existence of an account summary document that contained a balance forward of $1,016,281.78, which has been crossed out by hand and is not reflected in earlier or later reports. Id. at 17.
o Summary reports for the same time period contained different ending balances. Id. at 19.
o A balance forward adjustment, which decreased the amount owed to Plaintiffs, was not transparently explained or sufficiently supported. Id. at 20.
o Arista's documents misapply price categories such as " budget," " full

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price," and " mid-price." Id. at 22-24.
o Arista's documents inconsistently categorize income from synch licenses and are missing certain licensing income. Id. at 24-34.
o There are various discrepancies regarding ancillary income, for example, that Arista's witnesses did not agree on what was included in the ancillary income category, which consists, on average of over half the total reported royalties from 1984-2010. Id. at 34-38; 67-68.
o Mr. Coleman states that the pattern of reported royalties is not consistent with the over 600 re-releases of Plaintiff's music or with industry trends, such as the advent of compact discs. Id. 44-50; 60-61.
o The high percentage of reported domestic digital sales indicates to Mr. Coleman that much higher foreign digital amounts should have been reported. Id. at 53.
o The royalty documents from the 2000s applied incorrect royalty rates by deducting a 25% packaging charge for CDs per the 1975 Agreement. Mr. Coleman argues a 10% deduction should have been applied because a CD is a disc album and no CD amendment has been added. Id. at 56-59.
o Various documents indicate to Mr. Coleman that there were problems with delays in the processing of sales, various inconsistent peaks in sales and incomplete reporting and recognition of both foreign and domestic sales and earnings, and accounting discrepancies for compilations. Id. at 64-69.

The second step of Mr. Coleman's verification analysis was to compare the Arista records with the source information upon which the records are based. Mr. Coleman states that any underlying sales documentation provided by Arista is " as (or more) incomplete and unreliable than the various other documents." Id. at 72; see also Pl.'s Opp. At 3. Accordingly, Mr. Coleman could not complete the second step in his analysis. Based on his belief that Arista's records were wholly unreliable and unable to be tested against the source documents, Mr. Coleman proposes three alternative methodologies to construct the amount of royalties owed Plaintiffs. First, Mr. Coleman proposes a minimum royalty amount owed based upon the available records. Though Mr. Coleman argues that the accounting records maintained by Arista are incomplete and " entirely inadequate with respect to industry-accepted standards," he finds that this calculation totals $8,141,213, a " substantial underrepresentation of the royalties properly due to the [Plaintiffs]." Id. at 73-76.

As an alternative calculation, Mr. Coleman proposes a release-based method which uses identified releases to assess the number of sales. Id. at 79 . In constructing this estimate Mr. Coleman supplemented the sales records received from Arista with his own analysis of sales numbers and retail prices. He used sales awards for charted albums, the Bay City Rollers discography, public sources, and websites such as www.billboard.com, www.lescharts.com and various other websites. Id. at 80. Mr. Coleman calculated the amounts due using $9.98 as the average album price and $1.00 as the average single price, prices determined by reviewing pricing data and from his own research. He included a 10% packaging deduction, except for digital sales where he deducted nothing for packing.

Mr. Coleman applied a 12.2% royalty rate, which represented an average rate, to

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90% of the estimated retail price as per the agreement. Mr. Coleman added 48% for ancillary income from 1984 through 2012 based on Arista's data, 30% ancillary income from 1978 through 1983, and 10% ancillary income from 1975 through 1977. Id. at 80-81. Based on this analysis, Mr. Coleman's release-based assessment indicates royalties due Plaintiffs of $11,425,473. Mr. Coleman added interest, calculated at the statutory rate of 9%, of $29,510,419, for a total of $40,935,892, owed under his release-based calculation. Mr. Coleman notes again that this calculation under-represents the royalties owed Plaintiffs. Id. at 81-82.

Finally, Mr. Coleman proposes an interpolation assessment of royalties due Plaintiffs. He argues that " [u]nless and until [Plaintiffs] are afforded an opportunity to assess the royalties actually owed using detailed sales and other royalty records- which is not possible using the current set of documents produced by Arista- some form of estimation will be necessary to reasonably assess the amounts of royalties due." Id. at 85. Because Mr. Coleman believes the release-based estimate is under-representative of actual earnings, he presented the interpolation method based on his " experience in the industry, [Plaintiffs'] success and popular profile, the history of the music industry, and expected sales pattern over time of a band such as [Plaintiffs']." Id. 85-86. Mr. Coleman used assessments based upon certifications and documented releases for 1975-1977 as the " left" endpoint for the interpolation. He used the " reported royalties of the Sony documents as adjusted for expected audit amounts and identified royalty rate errors as the 'right' endpoints." Id. at 86-93. He then determined an " exponential decay function," which shows an initial sharp decrease tapering off in time, using " standard curve-fitting techniques." Id. 93-94. Mr. Coleman notes that he based the sales estimate for the period of 1975-1977 on certifications, chart rankings, and other public information because such information was abundant for the time period and thus reasonably could be used for the assessment. Id. at 94.

Mr. Coleman assumed that the royalties reportable on sales from 1975 through 1978 are reportable 50% in the year of release, 40% in the second year after release, and 10% in the third year. Id. He found not only that Arista's records for the period between 1977 and 2004 to be " wholly inadequate" regarding verifiable releases, sales, and royalties, but that the public record of this information was " notably deficient" as well. His conclusions are based upon the fact that he cannot find overseas sales data from public sources and does not believe Arista's records to be reliable in that respect. Id. at 95. After 2004, when Sony took over Arista and its record management, the records " offer some objective standard for measuring royalties due for those periods." Id. Mr. Coleman, therefore, used these figures, corrected for errors he identified,[2] as the baseline amount for the time period post-2004. Id. Based on the certifications and chart rankings in the mid-1970s, Mr. Coleman determined that the royalties owed from 1979 through 2012 amount to $32.8

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million and $112.7 million with the interest rate applied. Id. at 98.

Mr. Coleman expects to testify that Arista did not comply with its contractual obligation to provide regular royalty statements and render payments for accrued royalties. Additionally, he plans to testify that Arista's produced documents are inherently unreliable and cannot be used in determining the actual royalty income due Plaintiffs. Mr. Coleman plans to explain his three methods for calculation of royalties and present his calculations of royalties owed to the jury. Id. at 100.

2. The Rebuttal Report of Expert Tom Nilsen[3]

Mr. Nilsen has been in the music industry for more than 30 years and he has worked on behalf of both artists and record companies. Nilsen Rept. 1-2, Nilsen Rept., Ex. 1. He has worked for two major record companies, including as a manager in the domestic royalty accounting department of CBS Records and as a senior vice president of business affairs administration at PolyGram Records, Inc. Id. at 1-2. He has worked at Gelfand, Rennert & Feldman LLP for the last 12 years representing artists, publishers, and other royaltors in royalty examinations. Id. He has conducted or overseen hundreds of royalty examinations on behalf of a variety of parties, artists, and record companies alike. Id. at 1.

Mr. Nilsen's expert report addresses the main opinions offered in Mr. Coleman's report: (1) That Arista's records are " abysmal" and " useless" ; (2) that the " minimum royalty amount owed" to Plaintiffs is $2.9 million ($8.1 million with interest); (3) that available sales and royalties data should be ignored when determining whether additional royalties are owed to Plaintiffs, and, instead, a release-based estimate produces a reasonable estimate of royalties due to Plaintiffs ($11.4 million and $40.9 million with interest); and (4) the ...


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