A Brilliant Scam Based on the Structure of Spotify’s Revenue Streams and Contracts

As in yesterday’s post, I learned of this case from listening to the Money Stuff Podcast with Matt Levine and Katie Greifeld. Like yesterday’s post, this case is mostly about alleged criminal misconduct, but it’s a great story, and there is a contracts hook. In the Calm Knuckles episode of the podcast, Matt and Katie discuss the case of Michael Smith, who figured out a way to mess with Spotify’s system for paying artists and generated over $10 million of royalties for himself based on AI-generated music. 

Kate Knibbs did a deep dive on the story for Wired.  In order to understand Mr. Smith’s scam, you have to know something about how Spotify and other streaming services work. The streaming services provide a platform that connects artists to listeners. And since the artists create all of the content that is what listeners to the sites, obviously, the artists keep 95% of the revenues generated by monthly membership fees.

Psych! No, that’s not how it works. the streaming services keep most of the revenue they generate and give the artists the remainder.

Psych! No, that not how it works. The streaming services keep most of the revenue they generate for themselves, and they give most of what remains to the record labels, leaving artists with pennies per stream. So, unless your name rhymes with Sailor Drift, you aren’t going to make much money by getting your songs streamed. Unless of course you could produce your own music to cut out the middleman. But still you would need hundreds of millions of streams to make millions of dollars, and few people have that many fans. Mr. Smith, it is alleged, figured out how to get billions of streams without any fans.

Now, as the streaming services generate revenues from subscriptions, their take does not depend on how much content is streamed or which content is streamed. They don’t care if you subscribe but never download any content. They are going to grab their share of the pie, and they should be relatively ambivalent as to how the remaining crumbs get divided up. So streaming services are not incentivized to police streams all that carefully. They have to police things somewhat. Otherwise, no successful artists would want to be on streaming services because the crumbs would go to the people who had best rigged the system to pay them for streams, whether the listeners are fans or bots.

So, you could program a bot to play your songs over and over again, but the streaming service will be on to that game, and they would catch you.  You would have to program lots of bots to stream your music. Nope, the services would notice that the bots were all streaming the same songs or multiple songs by the same artist, and so they would be on to you again. What you would have to do if create a lot of music by a lot of different artists and then have a lot of bots that would randomly stream the songs of the multiple artists all the time. Then you would have to figure out how to make sure that all of the revenue that the bots thus generated by listening to all of this music you created to yourself without tipping off the streaming services that all of these different musical artists are actually just you. And that is what Mr. Smith allegedly did, using AI to compose the songs and then accumulating a huge inventory of fake music for his fake listeners to stream.

The practice is not unknown. Ms. Knibbs’ Wired story describes Mr. Smith as “the tip of the iceberg.” It is not illegal to make AI music, so long as one does so without infringing on copyright, but Mr. Smith is alleged to have used bots and fake accounts, which is a violation of the Spotify’s terms of service. Ms. Knibbs also reports that in some circles, Mr. Smith is seen as a hero, because he is a real musician, and the streaming services are seen as the enemies. But that doesn’t make any sense, at least as I understand the revenue structure. Mr. Smith isn’t alleged to have stolen any money from the streaming services. Their royalties payments to artists are capped at a certain percentage of revenues. The money that went to him would otherwise have gone to other artists. So he steals from the poor to give to himself. Not exactly Robin Hood.

Reading the indictment, it at first appears that Mr. Smith is alleged to have done nothing more than violate the rules of the streaming services and two performance rights organizations (PROs), which work with the streaming platforms to distribute royalties.  At least one of the PROs has some quasi-governmental status, and federal regulations provide that the PROs may not distribute royalties for manipulated streams. The PROs discovered Mr. Smith’s alleged fraud and halted payments, and he responded by denying any wrongdoing, challenging the authorities to provide proof of manipulation. He got his proof in the form of an indictment alleging wire fraud conspiracy to commit wire fraud, and money laundering conspiracy. 

All of this went down last September. Ms. Knibbs reported last month that Mr. Smith is out on bail. According to his attorney, “Mike Smith is a successful songwriter, musical artist, devoted husband, and father to six children. He looks forward to responding to the charges against him in court.” Ms. Knibbs also reports that Mr. Smith and his co-defendants in another case paid a $900,000 settlement in a lawsuit brought by staffers at his medical offices (music is his side-hustle, apparently) who alleged Medicaid and Medicare fraud. So this is not Mr. Smith’s first brush with allegation of illegal conduct. Stay tuned.