Royalty And Contract Compliance Services: A Practice Focused On The Entertainment Industry And Beyond

Editor: Mr. Stark, would you tell our readers something about your professional experience? .

Stark: I have been a CPA for over 15 years, and I started my CPA experience with a Big Four firm. Then I joined a business management firm in Los Angeles. It was there that I began my royalty and contract compliance auditing career. After six years, I joined an accounting and consulting firm in Los Angeles, where I expanded their royalty compliance practice into new areas, including the licensing of trademarks, brands, copyrights and patents. This was in the mid-1990s. I should note that in recent years the music and entertainment business has contracted substantially, but because of the diversification of my practice I had a good five- to seven-year head start on most of the competition. By 1997 or so, however, I had come to realize that much of the business on which I was focused originated in New York. I moved to New York to establish and operate the New York office of the same firm over the next seven years and developed an excellent royalty compliance practice. In 2004 I left to start a royalty compliance practice for a New York audit and accounting firm. Five months ago I moved that practice to Eisner LLP, where we are part of the Sports, Media, and Entertainment practice.

Editor: You have been witness to a great deal of change over the course of your career.

Stark: The entertainment industry, and particularly its music side, has changed dramatically during the 15 years or so that I have been associated with it. With the contraction caused by digital distribution, record companies have further limited the degree of access to their books and records, and we are working harder to give our clients value in this area.

Concerning the trademark and brand licensing industry, when we first started doing audits, this industry was where the entertainment industry had been 30 years earlier. That is, many companies were so focused on selling the product that they were not as concerned as they should have been on the quality of reporting and on the deliverables. What I have seen over the years with respect to licensing is an emphasis on improving the quality of reporting, controls, and procedures. I see the licensing companies spending more of their resources to either develop or purchase systems to help them with the controls resulting in more accurate accountings. Another major change is that the increase in volume has brought about a great deal more automation into the process. Overall, companies have become savvier with respect to the audit process, and access to documentation and information is less limited than it was even a few years ago.

Editor: Would you provide us with an overview of Eisner LLP and the services it offers its clients?

Stark: Eisner is a full-service accounting and business advisory firm. It provides a myriad of services across many industries. The basic services, of course, continue to be audit and accounting, tax, and business advisory services. There are many different services provided by niche groups, however - such as the royalty compliance group - and the firm has capacity of some reputation in litigation consulting and forensic accounting, corporate tax, business services, internal audit and risk management, and domestic and international tax, among other areas. There is also a very strong personal wealth advisory practice. Eisner offers the services one would find at a Big Four firm.

Editor: And the royalty and contract compliance group that you lead?

Stark: Our group is comprised of individuals dedicated to providing the highest caliber of royalty and contract compliance services. Each individual has been engaged in this type of work for at least ten years on the side of management. We are forensic auditors with extensive experience in this area, but we also provide financial due diligence, litigation support, consulting, and expert witness services.

We look for specialized experience in bringing people into the group, including experience in royalties at accounting firms or in corporate royalty departments. Those with good financial audit credentials are also appropriate, and we are able to bring them into the mainstream of our work in short order. Everyone comes from one or the other of these backgrounds.

The clients are diverse, but most operate in the entertainment industry and high-tech. They include performers, content providers for film and television programming, musicians and creative people generally, those providing a service pursuant to a royalty agreement. Content providers often spin off a variety of ancillary rights, including the development of characters or themes, that entail branding or trademark protection. Other clients - the apparel industry is a good example - own well-known brands or trademarks. Today strong brands, such as General Motors and IBM, are licensing their brands in ways that would have been unimaginable just a few years ago. Another vital aspect of our licensing work has to do with technology, and that our clients may include people who have developed patents and trade secrets they license out or exploit with the help of a partner.

Editor: And the services the group offers its clients?

Stark: The primary services are royalty audits and contract compliance services. Basically, these audits are designed to ensure that our clients are being paid properly and the licensee is in compliance with their agreements. The arrangement might entail royalties or some sort of profit participation, but there are a number of other ways in which compensation can be measured. What they all have in common is the fact that our clients do not know whether they are being paid properly because the books and records are in someone else's control. That is one of the reasons why they come to Eisner.

In addition, these clients retain us to protect their intellectual property (IP). They have licensed their IP to another party, and the actions of that party might have a detrimental impact on the value of the IP. The agreement usually specifies what may - and what may not - be done to exploit the IP, and we are often asked to determine whether these provisions are being followed properly.

Editor: What are the principle issues with respect to royalty and contract examinations that you and the group are addressing at the moment?

Stark: The protection of IP and prevention of royalty slippage are very important. There are varous reasons for royalties to be underpaid. Each party will interpret the contract in a way that is most favorable to its interests. Additionally, scenarios will arise that have not been considered at the time the contract was executed, and, as a result, the scenario may not be accounted for in the manner in which our clients intended. Furthermore, the contract may contain ambiguous language, enabling one party to take advantage. During our audit process it is not unusual to run across contractual interpretation issues, and we have to sort out the different ways in which the parties interpret the contract and determine the effect on royalties.

Another issue we encounter on an ongoing basis is mistakes. Parties often fail to put sufficient resources into their royalty function to avoid mistakes, and the absence of appropriate resources and controls usually results in the underpayment of royalties. Even large organizations - where the right hand may not know what the left is doing - make mistakes. Products may be developed utilizing our client's IP, but the production department fails to advise the royalties department. Even if the company has a license to exploit the IP, the production group may not be aware of the terms of the license agreement and be in violation of it, albeit unintentionally. Occasionally we encounter companies with very aggressive, even borderline fraudulent, accounting practices. Sometimes a company is simply lazy in administering a contract. The contract might specify that the company is entitled to deduct certain expenses up to a specified percentage from the royalties payable to the owner of the IP, and the company simply deducts the entire percentage without bothering to analyze what, precisely, the contract permits to be deducted. This type of issue comes up frequently.

Editor: You talk about the owner of the IP as the client. Are there occasions where you would represent, say, a distributor of the IP or some party other than the owner?

Stark: There are times when we represent people needing help in complying with a royalty arrangement or in defending an audit. In certain respects this is a very small industry, so we are constantly checking to see whether a particular project might place us into a conflict of interest situation.

Editor: How about the global issues that arise, increasingly, with many of the clients Eisner serves?

Stark: This practice has always been global in its reach, as licensing is a global activity. As a consequence, we have a number of global enterprises among our clients, and we are engaged in auditing international licensees on an ongoing basis. I am just back from Brazil, and I am constantly called upon to be in Europe. Eisner is also an independent member of Baker Tilly International, the eighth largest accounting network in the world. As a part of that network we are able to service clients globally with our international experience and with our affiliation with Baker Tilly International.

Editor: What are the trends here? How do you see your practice developing over, say, the next five years?

Stark: One of the principal trends has to be the emergence of electronic transactions. That means that there will be a need to bring more computer expertise to the audit process. Another trend is that more organizations, large and small, are getting into the licensing business, and that means that there could be a greater need for auditors who understand royalty compliance.

Published February 1, 2008.