No Royalties : Cut-Rate Albums Hit Sour Note

On a recent weekend, customers at Aron’s, a West Hollywood record store, could buy a copy of rock star Eric Clapton’s 1983 album, “Money and Cigarettes,” for the full price of $6.29. Or, if they took the time to flip through the nearby budget record bin, they could find the same album--brand new, still factory-sealed except for a missing top corner--for just $3.98.

These days, consumers are finding it easier to buy new copies of record albums at well below the full retail price. That has created controversy and a hint of scandal in the multibillion-dollar record business.

Few in the industry are willing to discuss it. The situation involves records that either never were or no longer are big sellers and for which artists usually are not paid royalties. In industry parlance, they are “cutouts,” meaning that they have been deleted from the record companies’ sales catalogues because they are not in demand.

100 Million a Year

The major U.S. record companies sell huge amounts of cutouts--some experts estimate more than 100 million a year--to a network of budget record and tape distributors around the country. The cutout distributors, in turn, sell them to record stores, which offer them to consumers at prices considerably lower than the record companies’ current, or “front-line,” recordings. Album covers of cutouts are usually missing a top corner or have been cut or punched to distinguish them from front-line products.

Record companies point out that they are contractually allowed to make mass sell-offs of cutouts, in most instances without paying royalties to the artists. They also can liquidate excess inventory of non-cutout recordings, called “overstocks,” usually with the consent of the artists and with some agreed-upon lower royalty rate.

Quick Cash

However, critics of these sell-off practices have been complaining for years that record companies use the cutout and overstock designations arbitrarily to raise quick cash at the expense of the artists. They say that cutouts and overstocks often are routinely sold, bartered or given away by the record companies to cutout distributors, favored retail accounts and even company employees. In most cases, the artists receive no royalties.

What’s more, the Recording Industry Assn. of America, a trade group of the major record companies, contends that mass sell-offs help create an atmosphere conducive to counterfeiting by providing illegal duplicators with a “cover” to produce large quantities of the recordings that have been sold by manufacturers as cutouts and overstocks.

In researching this article, The Times attempted to contact the appropriate executives at the major record labels as well as the top cutout distributors around the country. Most either refused to discuss the subject or failed to return phone calls.

The controversy may be coming to a boil. Consider:

--Los Angeles-based MCA Records announced recently that it had ceased all further cutout sales in the wake of a disclosure by The Times that a large number of suspected counterfeit cassettes by MCA artists were being distributed to major record stores around the country on the pretense that they were cutouts. The suspected counterfeits--samples of which MCA turned over to the FBI--included works by such top-selling performers as Neil Diamond, Elton John, Tom Petty, The Who, Jimmy Buffett, Steely Dan and Olivia Newton-John.

MCA sold a total of 15 million cutouts and overstocks in 1983 and 1984, an unusually large number considering that the company is the smallest of the major U.S. distributors of front-line recordings.

Capitol Sued

In one cutout sale last spring, the individual who acted as middleman between MCA and the buyer was Salvatore Pisello. Federal authorities have identified Pisello as a reputed organized crime figure in papers filed in U.S. District Court here.

--Capitol Records is being sued for $45 million by its most famous and successful recording artists, the Beatles, who allege that the company defrauded the group by failing to pay royalties on about 20 million records that the company says were destroyed as scrap but that Beatles attorneys contend were actually sold for cash in “back-door” deals with cutout distributors. Capitol has denied the allegations.

--The Beach Boys are suing their former record label, Warner Bros., for a total of $7.7 million, alleging, among other things, that the company defrauded them by refusing to pay royalties on more than 400,000 recordings sold as cutouts when the group left the label three years ago. Lawyers for the group contend that the recordings were never cut out of Warners’ sales catalogue but were wrongly labeled as cutouts so the company could avoid paying royalties.

A spokesman for Warner Bros. said the Beach Boys’ suit involves contractual interpretations on 10 different issues, including cutouts, but he refused to comment further.

May Be Bad Business

The few record executives who did talk acknowledged that selling cutouts and overstocks sometimes is poor business policy because the recordings invariably wind up back in the stores competing against the companies’ higher-priced front-line merchandise.

“We try not to participate in that end of the business,” said A&M; Records Chairman Jerry Moss. Although A&M; made some large cutout and overstock sales when the company ran into financial and distribution difficulties in 1979, Moss said, “For years our philosophy has been that when you make cutouts available at a lesser price you devalue the artist. I don’t think anyone (selling cutouts) really believes in the future of those artists.”

Capitol Records seldom sells cutouts and never sells overstocks because “they absolutely compete” with front-line merchandise, said Capitol Executive Vice President Dennis White. For the most part, he said, “We grind them up.”

However, after singer Kenny Rogers left the Capitol-owned United Artists record label two years ago to sign with RCA Records, Capitol deleted from its sales catalogue virtually every album Rogers recorded for UA--including his multimillion-sellers “The Gambler” and “Gideon”--and sold large quantities on the cutout market.

Such sales of cutout recordings by artists who have left the label are common in the industry. Said Rogers’ manager, Ken Kragen: “My understanding is that Capitol was looking for a way to generate cash and their feeling was that Kenny’s career is no longer their concern.”

In some cases, major artists have enough leverage with their record companies to negotiate clauses in their contracts stipulating that excess inventory will be destroyed rather than sold on the cutout market. Both the Beatles and the Beach Boys had such clauses.

However, David Ravden of the London-based accounting firm of Goldberg-Ravden, which has been auditing record companies on behalf of artists for 10 years, said that even in these cases the record companies often “don’t produce any evidence of destruction.”

“In other industries, like publishing, when unsold goods come back they have detailed reports and affidavits of destruction--and this is with unsold magazines, which have no real value, whereas records are like currency on the street,” Ravden said.

Better Than Gold

One 30-year record-industry veteran involved in cutout sales put it even stronger. “Records are better than gold because gold can’t be turned over to you and me and the lady down the street,” he said. “You can’t (readily) sell gold, but you can sell records, even old records, faster than you can spit.”

According to Leonard Marks, a New York-based attorney representing the Beatles in their case against Capitol Records: “Record companies use copies of records in lieu of cash payments for all kinds of things--window displays in record stores, air play on radio stations, and to make various (payments) that are difficult to trace.”

In fact, Marks said, in the course of the Beatles’ audit of Capitol, auditors found that the company had used Beatles albums as cash to pay retailers for window displays of records by other Capitol artists.

Russ Solomon, owner of the Tower Records chain, confirmed that the major companies sometimes pay for their share of cooperative advertising with free records.

Number Sold

Marks said such problems are complicated by the fact that, according to virtually all artist contracts, record companies only have to account to the artist for the number of recordings sold, not the number manufactured.

“In an audit, which the artist has to pay for, the one document the record company will never divulge, short of a court order to do so, is the one showing how many copies of a record were actually pressed,” he said.

“The point is, without access to the complete manufacturing and inventory records, it’s almost impossible to successfully audit and trace all of the disappearing albums and the uses to which they have been put by the record companies.”

In addition to using records for payments to retailers, the major companies sometimes use cutouts as barter for such things as TV and radio advertising time, hotel rooms, airline tickets and prizes for sales employees.

Fred Tarter, president of a New York-based barter company, Deerfield Communications Corp., said that in the last several years his company has “probably moved 50 million (cutouts)” in barter deals with the major record companies.

9 Million From MCA

Last year, Tarter bartered for 9 million cutouts from MCA alone, at prices ranging from 35 cents to 75 cents apiece. “My guess would be that 15% to 20% of (all records) sold each year are eventually cut out,” he said.

Record company executives say there is no profit in cutout sales, but critics disagree. They point out that once a record has sold enough copies to pay for the cost of its initial production--a cost that is deducted from the artist’s royalties--the per-unit cost of manufacturing is well below $1 and sometimes less than 50 cents.

Because there are no advertising or promotional costs involved in selling cutouts, some cutout sales do produce profits for the companies, they contend.

“In some cases, manufacturers find it easier to continue pressing to keep their plants busy and their employees working, knowing that at the very least they will be able to recoup their manufacturing costs,” one industry attorney said.

‘Schlocking’ Records

There is also a practice known as “schlocking,” the manufacture of records specifically for sale as cutouts. Former Elektra Records Chairman Joe Smith said: “It’s not unknown for companies to press copies of cutouts, especially in cases where, for example, the artist is in a deficit position (meaning his or her record has not recouped its initial production costs), pressing costs are about 70 cents and a cutout guy is willing to pay $1.25.”

By all accounts, the cutout business is dominated by a handful of companies, the two largest being Chicago-based Surplus Records & Tapes and Jericho, N.Y.-based Countrywide. Executives at the two companies either refused to discuss details of their business dealings with the major companies or failed to return a reporter’s phone calls.

Executives of the major record companies denied there is anything unethical or illegal about their cutout and overstock sales. Most refused to discuss specifics, however, saying they feared alienating or embarrassing artists whose records failed to live up to expectations.

Current catalogues from cutout distributors offer scores of recordings that would seem unlikely candidates for cutout status. These include recent hit albums by The Kinks, Eric Clapton, Randy Newman and Lindsey Buckingham as well as earlier multimillion-sellers by Linda Ronstadt, Rod Stewart, Stevie Wonder and Fleetwood Mac.

Manilow Albums Sold

Arista Records recently sold nearly 700,000 cutout albums and cassettes by one of its most successful artists, Barry Manilow. Neither the record company nor Manilow’s manager would comment.

The sound-track album “Against All Odds,” on the Atlantic label, was being offered in Countrywide’s catalogue for $2.25 the same week that the album’s title song, by Phil Collins, was up for an Academy Award.

“Against All Odds” has not been deleted from Atlantic’s sales catalogue, according to the label’s vice president of sales, Sal Uterano. He said he did not know how Countrywide could be selling the album for $2.25--indicating that the budget distributor had purchased it for about $1--when the manufacturer was still selling it at full price. “It’s a very strange thing,” he said.

When asked who at Atlantic was responsible for making cutout sales, Uterano replied: “More or less, the financial people handle that.” He refused to be more specific.

A call to Countrywide elicited little enlightenment. Countrywide President Stanley Sirote referred a reporter back to Atlantic Records. Asked with whom he dealt at Atlantic, Sirote replied: “I’d rather not say.”