Kim Dotcom’s business facilitated more online piracy than the mind can conceive. Yet it might have been legal. How did we get here? Is there any way out?
FORTUNE — In a climate-controlled warehouse in Harrisonburg, Va., 1,103 computer servers, each equipped with 24 hard drives, are piled in 120 stacks awaiting a federal judge’s decision about what to do with them. Together, they store more than 25 petabytes (25 million gigabytes) of information. That’s enough space to store 50 Libraries of Congress, 13.3 years of HDTV video, or “approximately half of all the entire written works of mankind, from the beginning of recorded history, in all languages,” according to Carpathia Hosting, the company that owns the hardware.
For several years Carpathia leased the servers to a company called Megaupload, which deployed another 700 or so servers in the Netherlands and France. At one time Megaupload alone accounted for 4% of the globe’s entire Internet traffic and was the 13th-most-visited site on the web, according to the government, with more daily visitors than Netflix (NFLX), AOL (AOL), or the New York Times.
Until recently Megaupload was one of a number of lucrative, businesses known as cyberlockers, which are the latest generation of operations created in the image of the original Napster — the pioneering file-sharing service that launched in 1999 and was shut down by court order in 2001. In January an Alexandria, Va., federal grand jury charged Megaupload and seven top officials with a racketeering conspiracy focused on aiding and abetting criminal copyright infringement. The government alleges that the defendants, led by Kim Dotcom, a.k.a. Kim Schmitz, a.k.a. Kim Tim Jim Vestor, made $175 million from a business built on facilitating the illegal distribution of at least $500 million worth of copyrighted movies, music, television shows, books, images, videogames, and software.
Cyberlockers — others include Rapidshare and Hotfile — make money by selling both advertisements and premium subscriptions. The subscriptions enable users to download or stream files more quickly than free users can.
They work like this: Users upload files to “lockers,” though the lockers typically have no locks. (“Uploading” means copying a file from the user’s own computer onto the cyberlocker company’s website, where the file is stored on one of the company’s servers.) Most uploaders then publish the name of the file and its locker URL on public blogs or “link farms,” from which anyone in the world can download or stream the materials stored there, using a search engine to find the link. In pending civil litigation against Megaupload’s rival Hotfile, a movie industry statistician whose surveys have been accepted by many courts found that more than 90% of that service’s downloads were infringing.
In a click-through agreement that appears to serve as a fig leaf, cyberlockers require their users to agree not to upload infringing materials. Nevertheless, most cyberlockers seem to encourage users to do just that. Until they started getting hit with civil copyright suits, many cyberlockers offered cash bounties to users based on, for instance, the number of times other people downloaded whatever the users uploaded — $15 to $25, say, per every 1,000 downloads. Such paid users were called “affiliates.” One Megaupload affiliate uploaded 16,950 files to the site over six years, the government says, generating more than 34 million page views. (Since the Megaupload indictment, many cyberlockers have altered their practices.)
The lead attorney for Kim Dotcom and Megaupload, Ira Rothken of San Francisco, says that Megaupload was a “cloud storage” business whose technology was “nearly identical” to that used by such legitimate businesses as Dropbox, Microsoft (MSFT) SkyDrive, and Google Drive. “Megaupload appears to be the perfect example of something protected under the Sony doctrine,” Rothken says, referring to the landmark 1984 U.S. Supreme Court case Sony Corp. of America v. Universal City Studios. In that case, the court found that Sony, in selling its Betamax videotape recorders, could not be held liable for the fact that some customers might use them to infringe copyrights.
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