The Lowdown Download Blues

It was sheer anarchy. That’s exactly what transpired in the late 1990s when teenage computer whiz and college dropout Shawn Fanning created Napster--a system that connected computer owners and allowed them to swap music files over the Internet. The $40-billion music industry reeled as a generation of young computer users, completely ignoring the notion of copyright, adopted a disturbing credo: Why pay for music you can get for free? By May 2000, it was estimated by the Internet research firm Webnoize that 73% of U.S. college students were using Napster.

In these excerpts from the book “All the Rave: The Rise and Fall of Shawn Fanning’s Napster” (to be published April 15 by Crown Business), Times staff writer Joseph Menn chronicles how a few unworldly kids almost caused the powerful music industry to implode: Artists were caught between trying to maintain their livelihoods while not appearing greedy to their fans, and at one point, the German media conglomerate Bertelsmann AG antagonized its peers by financing Napster at the same time its own BMG record label was suing to shut down the online service.

In her ruling against Napster, the presiding judge noted that technology had gotten ahead of the law. It also had gotten ahead of reason: If Fanning and his young colleagues didn’t understand the full implications of what they had created, the professionals in charge of Napster’s business didn’t care. The music industry understood, but it had no idea how to stop the juggernaut.

As Napster is stymied (the site is in limbo as its new owners attempt to develop a pay-for-play service), its legacy continues to spiral outward: Pirate successors now combine for a bigger reach than Napster had at its peak; Hollywood and Silicon Valley are jousting on Capitol Hill over whether widespread anti-copying mechanisms will be mandated in future computers; and sales of blank CDs, often used to make custom discs of downloaded music, now top sales of prerecorded CDs.

It all began with a poor Boston-area kid who came west to Silicon Valley and started a revolution.

Shawn Fanning and Sean Parker packed their bags for California in September 1999 because Napster’s first equity investor, Yosi Amram of Palo Alto, wanted to keep an eye on the company. Parker took what he could carry from Virginia and went to the airport. Fanning was to fly the same day from Boston, but he misplaced his driver’s license and couldn’t make the flight.

When Parker arrived at the San Francisco airport and discovered his partner wasn’t there, he realized he was alone in a city where he had no friends, no support network and no place to stay. Fanning arrived a day or so later, exhausted. “I was in really bad shape, just from programming for eight months,” he said. “I was going to a strange place. I didn’t get a sense of what I was getting into or really much of an understanding for what it meant to start a company or raise money or any of those things.”

They were relying on the experienced adults in the company, such as Napster CEO Eileen Richardson. But Richardson hadn’t done enough homework. She said that her first question to Amram before she signed on had been about copyright law. Anything as powerful as Napster, which took away so much music without paying any money to the labels, had to be illegal, she worried. Amram assured her it wasn’t, and he told her about a lawsuit-defense memo that had been prepared for the company. That was enough to convince her. She was foolish for not doing at least a modicum of due diligence and speaking to a lawyer. But she thought people would just use Napster to sample music, then purchase what they liked. CD burners were rare at the time--they would soar in popularity later, precisely because of Napster.

Richardson decided to move fast to raise more money. After word about Napster had leaked out in June 1999, 100,000 users had downloaded a test version. When college students returned for the fall term, Napster had the potential to turn into the ultimate case of viral marketing, with word of mouth spreading it faster than any advertising could. But the usage was already straining Napster’s capacity, and the system kept crashing. If the positive buzz was replaced by griping about the crashes, Napster could die before its first official release.

By the end of their first week in Napster’s San Mateo office, Fanning and Parker had been surprised so many times by the chaos that they began referring to the encounters as “What the hell is going on?” moments. “We didn’t have any real world experience to process what was happening to us,” Parker said. “It really felt like we were in a movie.”

Neither Bill Bales, VP of business development, nor Richardson seemed to think that a business plan mattered much. Parker would call strategy meetings and try to explain what he thought the company’s next steps should be. “I would put on a presentation for Bill and Eileen, and halfway through, she would start screaming and running around the office, saying, ‘We have so much to do!’ Bill would say, ‘That’s brilliant! We’re going to be a $10-billion company!’ And I would say, ‘Wait, I’m not finished yet.’ ”

The executives thought that by just getting big quickly, they could force the record industry to the negotiating table--how to structure a legitimate and sustainable business was simply not the focus. Once, John Fanning--Shawn’s uncle and Napster’s then-largest shareholder--sent a deputy out from Massachusetts for an inspection. When Tom Carmody was done, he called everyone together. “A business is like a person,” he said. “Napster has a spirit. It has a body. But it doesn’t have a brain.”

Despite Richardson’s presence and the increasing number of Silicon Valley pedigrees, it sometimes appeared there were no grown-ups in charge. One day, Bales took Fanning, Parker and engineer Jordan Ritter to look at a house where they all might live. The real-estate agent pulled Ritter aside and told him that his credit record was the only one of the four that qualified, and Ritter balked at signing the lease alone. There would be no MTV-style house to throw parties in.

“Fun, early on, was going to 24 Hour Fitness at 2 in the morning,” Fanning said. “If I could get enough work done during the day, I would reward myself by going to the gym.” Even when he had time to explore, he said, “it’s really hard to find a scene out here that’s not a bunch of geeks.” Instead, after some long programming sessions, the young men blew off steam with drinking games. Most pot smoking was done on the roof, but once it went further, with Bales and Parker slipping into an office and closing the door. A telltale odor seeped out. “The entire office reeked,” said Ritter, who admitted taking a hit himself. After a second incident, both Ritter and Fanning, who as a rule didn’t partake, told Parker never to smoke dope in the building again.

in november 1999, webnoize said the record- ing Industry Assn. of America intended to sue Napster. Wired magazine confirmed the report, citing an association spokeswoman who said the trade group had repeatedly sampled what was available for download on the service and found that “virtually all file traffic is unauthorized.”

The following month, the recording industry filed a lawsuit accusing Napster of copyright infringement. It came armed with evidence, showing how Napster was involved in every step of the process. The suit attached a list of a couple hundred songs available on the site, including cuts by Elvis Presley, the Beatles, Jimi Hendrix, Bob Dylan and Bruce Springsteen. Since the statutory penalties for copyright infringement maxed out at $100,000 per work infringed, 200 songs meant $20 million in potential damages. And those songs on the sample list were just the tip of the iceberg.

As Napster was lining up support from rock bands, many of whom thought free promotions were a good idea, so was the recording association. It pressed its member labels to get artists to come out against Napster, and some, such as Peter Gabriel, obliged. “This is obviously a big business that was built by taking stuff without the consent of the artists who created it,” Gabriel said. Rapper Eminem was more blunt: “I’ve seen those little sissies on TV, talking about [how] ‘The working people should just get music for free.’ I’ve been a working person. I never could afford a computer, but I always bought and supported the artists that I liked.”

The record industry’s biggest public-relations victory came in mid-April 2000, when the rock group Metallica filed suit against Napster in federal court. Metallica accused the company not only of copyright violations, but also of running afoul of the Racketeer Influenced and Corrupt Organizations Act through its repeated transgressions. Rap star Dr. Dre also sued and demanded that his songs be removed.

A “Save Napster” hacking campaign started online, and probably the biggest contributor was 16-year-old Robert Lyttle, who broke into more than 200 Web sites and left a pro-Napster diatribe on each. He also offered to patch the security hole he had come through--for a fee. Among his victims were sites run by NASA, the U.S. Army Materiel Command and the French Bibliotheque Nationale. Lyttle sent messages to Fanning and Ritter and told them what he had done for their cause. The two looked at each other in horror. Fanning responded, typing: “Are you crazy?”

the record industry was generally hostile to Napster, but some in the industry thought Napster had too much potential to be ignored. Two of the biggest record industry doves were Ted Cohen and his boss Jay Samit, an executive vice president at EMI and much more of a technophile than an industry man. Cohen set up a meeting between Napster and Samit for December 1999 to explore possible alliances. Bales came down for the get-together on the top floor of the historic Capitol Records tower in Hollywood. So, Samit asked him, how does Napster work? What’s the business model? Bales explained that Napster didn’t have a model yet--it was just letting people get music for free. “I explained that that was illegal,” Samit recalled. “He didn’t have any clue.” Bales said he would get back to Samit once Napster worked out a business plan. He never did.

Bales also met with Tom Gieselmann, an investor with Bertelsmann’s venture-capital arm. Gieselmann thought Napster had tremendous potential, and he said he wanted to discuss investing. Meeting Bales in San Francisco, Gieselmann promised to introduce Napster to Bertelsmann CEO Thomas Middelhoff and others, and he began quizzing Bales about Napster’s closely guarded usage and file-swapping numbers. “I had to give him something to make sure he stayed interested,” Bales said. Gieselmann started doing the math on an envelope. His face turned pale. “He was like a ghost,” Bales recalled. “You guys are destroying the record industry,” Gieselmann told him. “You’ve distributed more music than the whole record industry has since it came into existence.”

Even then, many record executives didn’t see how dire the situation was. That changed the day after the Grammy Awards in February 2000. At a board meeting of the recording association at the Four Seasons Hotel outside Beverly Hills, chief executive Hilary Rosen decided to try a little show-and-tell. It had been a good year for the industry, and people were feeling upbeat.

“You know about Napster,” Rosen told them, “but you need to understand it. This is going to be big, and the fact that we sued them is going to make it bigger.”

Staffers downloaded the software and registered in front of the label bosses. Then Rosen asked the executives to start naming songs. Not just big hits, but tracks deep into albums, new or obscure. The record men took turns calling out more than 20 songs. The staffers found them every time, and fast. Soon no one needed any more convincing that the threat was serious. The capper came when someone suggested a hunt for the ‘N Sync song “Bye Bye Bye.” The cut had been on the radio just three days, and the CD hadn’t been released for sale yet. And there it was.

Maverick Records executive Ronnie Dashev had seen enough. “This is too depressing,” he said. “Let’s move on to other business.”

the venture capital firm hummer winblad, confident that Napster would prevail in court, agreed to invest $13 million in the company on May 21, 2000. Happier than he had been in many months, Fanning didn’t have to wait long to celebrate his new status as a legitimate player in Silicon Valley. That very night, Ron Conway, an early Napster investor, held one of his over-the-top charity-and-networking bashes at his home, and Fanning and Parker were on the 300-person guest list, right there with billionaire investor Warren Buffett. Fanning almost felt as if he belonged with the others as they drank champagne and munched on scallops wrapped in pancetta. Almost, but not quite. “It was like a circus. I was very awkward going there. I had no idea what I was supposed to wear,” Fanning said. He was introduced to Netscape co-founder Marc Andreessen, who asked how many users Napster had and offered words of encouragement. “Controversy can be a good thing,” he said, “as long as you know how to navigate it.”

“We thought we had been inducted into this inner circle, where everyone you bumped into was worth $50 million,” Parker said.

Meanwhile, Richardson had accomplished most of what she had set out to do and was ready to step down. Hummer Winblad put in Hank Barry as her temporary replacement. Barry was a corporate lawyer only recently turned venture capitalist, with no real way of bonding with the kids doing most of the actual work at Napster. Yet Barry harbored a rebellious streak that was unusual for one in his position. Not too many big-firm lawyers or venture capitalists had spent seven years playing rock ‘n’ roll. With Napster, the Silicon Valley lawyer turned private investor would be transformed magically back into Hank the Cool Drummer, He Who Brings Music to the People.

What Barry said he saw in Napster was what everybody else saw--a terrific application with an incredible rate of adoption, something that had potential if you could make it work for everybody, including the record industry. John Hummer, Barry’s venture-firm partner and fellow Napster director, called Edgar Bronfman Jr., CEO of Seagram Co. Ltd., which owned the largest record firm, Universal Music. Bronfman was confident that the music industry would win in court, but he was still open to a potential settlement. “The notion was that Napster was only the first--there will be others to replace it,” he said. “Here was an opportunity to maintain a large customer base, potentially, and over time migrate it into a commercially viable system.”

Bronfman met with Barry, Hummer and others to discuss what Napster’s business model might be. The ideas came fast and furious, but there was no technology available to make Napster legitimate, and the company was reluctant to charge its users. Without charging them, Bronfman said, there didn’t seem to be any way that Napster could make a profit even before it paid artists and the record companies. Yet both sides realized the prospects for a deal were best before the court ruled on the industry’s lawsuit--especially if the judge found that Napster was breaking the law, which would give any new owners a massive liability headache. So Bronfman arranged for a summit meeting to be held with other label executives in the most conducive setting for deal making he could imagine--investment banker Herb Allen’s annual media-moguls-only conference in Sun Valley, Idaho.

The two Napster directors met there with Bronfman, Bertelsmann’s Middelhoff, Sony Corp. co-CEO Nobuyuki Idei and Sony’s U.S. chief, Howard Stringer. The meeting went well, and Idei and Middelhoff told Barry to keep dealing with Bronfman, who wanted to craft an industrywide deal. “We were very close,” Bronfman said. A week later, Hummer changed direction. “He said he had another offer . . . and that unless we wanted to buy Napster for $2 billion, he would walk away,” recalled Bronfman, who told Hummer there was no way the record companies would pay that kind of money. No deal was struck.

More than a few of Napster’s employees and most of its fans would have been disappointed by any compromise with the labels. The service’s popularity had always contained an element of perversity: Napster offered an easy way to break the law. As Napster neared the end of its rope in court, that perversion intensified. The more endangered the company became, the more users flocked to the service to get what they could while they still had the chance. And that added to Napster’s strategic dilemma. “Your biggest problem,” the recording association’s Rosen told Barry, “is that instead of a business, you created a movement. And it’s impossible to convert it.”

All the online traffic, combined with the Robin Hood pose, made Shawn Fanning an international celebrity. And he was beginning to enjoy his relative wealth. He bought a BMW convertible and spent thousands of dollars constructing a makeshift recording studio to go with the gym and pool table in his plain but spacious Mountain View home. And he didn’t fend off all of the women who sought him out.

strauss zelnick, ceo of bertelsmann’s re- cord label BMG, was at home when Bertelsmann e-commerce chief Andreas Schmidt called. “We’re investing in Napster,” Schmidt said. “We’re dropping [out of] the suit and making the announcement tomorrow.” Zelnick couldn’t believe it. He went into overdrive trying to persuade Schmidt and Middelhoff to rethink their decision. Zelnick argued that if Bertelsmann made a deal with someone violating copyright protections, the company could be putting its own vast treasure of copyrights at risk. Under the legal doctrine of unclean hands, courts frequently dismiss claims of wrongdoing when the complaining party has committed the same offense. And he said that if Bertelsmann was still intent, it should simply wait for Napster to go bankrupt, then buy its assets in court. Schmidt countered that Napster wouldn’t go bankrupt and might even soon file for an IPO, that its legal fortunes had turned.

Like others before him, Middelhoff was seduced by Napster’s technology and incredible audience. But he was far less reckless. Unlike Barry, he wasn’t sure Napster was legally defensible. “It is true that this private exchange of music via the Internet has thus far infringed upon the copyrights of artists and record companies,” he wrote to colleagues. Instead of a direct stock investment, he was willing only to make Napster a loan as it worked up a new, legal system. At Zelnick’s insistence, BMG wasn’t party to the parent company’s deal and would keep its part in the lawsuit alive.

It wasn’t enough for Middlehoff to convince his own troops. He also had to entice Fanning into staying as Napster’s very public face. Fanning was surprisingly hard to convince. “I had a lot of concerns about it,” he said. “There was this whole notion of selling out to a label.” Fanning called his mother, telling her he was thinking of walking away from Napster for good. She encouraged him to stick with what he had started.

Middelhoff treated Fanning to dinner at Manhattan’s Post House, where they had steaks and a $219 bottle of Phelps Insignia Cabernet. “Four days before the deal was disclosed, Napster added sweeteners for Fanning. The company raised his salary to $120,000, promised a bonus of $60,000 and vested the remaining 993,000 of his 2.7 million shares. He began to focus on the bright side. “It was a really good relationship in terms of deals and trying to get licenses and security and stuff. Those were all new issues for me that took a while to get comfortable with. Overall, it was definitely the right choice,” Fanning said not long after. “We wouldn’t be here if Bertelsmann had not decided to fund the company.”

Bertelsmann’s largess didn’t stop the legal process, which forced Napster’s shutdown in July 2001. Since its $85 million in loans made it Napster’s largest secured creditor, Bertelsmann then offered to buy the firm’s technology through a planned bankruptcy reorganization Napster filed in June 2002. But a judge refused to approve the sale, ruling that Bertelsmann might have been wielding too much power over Napster during the negotiations. Instead, Napster’s system and Web site were sold at auction to Silicon Valley software firm Roxio Inc.

On Feb. 19, 2003, renowned songwriters Jerry Leiber and Mike Stoller and music publishers Frank Music Corp. and Peer International Corp. sued Bertelsmann for $17 billion, accusing the company of deliberately helping Napster users violate millions of copyrights. The suit in New York federal court seeks class-action status for about 160,000 songwriters and their publishers and is based largely on evidence that emerged in Napster’s bankruptcy proceedings, including Thomas Middelhoff’s memo concluding that Napster users were breaking the law.

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Shawn Fanning

Raised in a blue-collar home outside Boston, Shawn came up with the idea for Napster while a Northeastern University freshman, then dropped out to work on the project. World famous by the end of 2000, he stayed at the company even after the site shut down, resigning in September 2002.

John Fanning

Shawn’s uncle played an active role in his nephew’s life, employing Shawn at his struggling Internet chess firm. He incorporated Napster and kept 70% of its stock, to Shawn’s dismay. As Napster’s first chairman, he drove away cautious investors and plotted a collision course with the record industry.

Sean Parker

A friend of Shawn’s from northern Virginia, Parker was more business-minded. He drafted the first strategic plans and introduced Napster to potential investors. Parker’s cavalier e-mails about Napster users exchanging pirated music help sink the company in court. He left Napster in 2000 and founded a software firm.

Eileen Richardson

Napster’s first full-time CEO was an experienced venture capitalist but had never led a company from the inside. Worse, she didn’t meet John Fanning or research the legal issues before signing up. Richardson played dumb with the record labels and managed to raise venture funding for the firm.

Bill Bales

Napster’s vice president of business development and one of its first employees, Bales was a Silicon Valley veteran. But he behaved erratically, clashing with his colleagues and allying himself with John Fanning against Richardson. After launching another file-sharing start-up that fizzled, Bales left California.

Hank Barry

A longtime corporate lawyer, Barry became a venture capitalist only the year before he recommended that his venture firm, Hummer Winblad, invest in Napster. Believing Napster would win in court, Barry replaced Richardson as CEO, taking a tough and unsuccessful line in negotiating with the labels.

Thomas Middelhoff

As CEO of German publishing conglomerate Bertelsmann AG, Middelhoff pushed the conservative firm in new directions, including controversial loans to Napster. He too failed to get a deal with the labels and was thwarted in his attempt to buy Napster’s technology last year before resigning from Bertelsmann.