Megaupload Arrests May Deter Technology Entrepreneurs

(Corrects writer’s name in Jan. 27 story.)

If Hollywood needed to cast a villain for a movie about the fight against online piracy, it couldn’t have done a whole lot better than Kim Dotcom.

The German computer programmer and founder of the online file-storage service Megaupload lived larger than a James Bond foe. Dotcom, who legally changed his name from Kim Schmitz, lived in a $24 million mansion outside Auckland and drove luxury cars with license plates that read “Mafia” and “Guilty.”

The former hacker, convicted in the early 2000s in connection with one of the largest insider-trading scandals in Germany, is in legal trouble again. New Zealand police arrested Dotcom with three co-workers on Jan. 20 as part of what could be the biggest criminal copyright infringement case ever.

U.S. authorities have accused the four of willfully and repeatedly violating copyright law, alleging that executives knew of the illicit content on their servers and paid users who uploaded it. The music and recording industries want U.S. authorities to make an example of Dotcom, Bloomberg Businessweek reports in its Jan. 30 issue.

That’s what concerns the technology world, especially the online locker services that, like Megaupload, allow users to store data, pirated or otherwise, remotely and gain access to it anywhere. Many in Silicon Valley say the government’s case against Megaupload will scare away investors and entrepreneurs that would otherwise create the next Dropbox Inc., a darling of the cloud-storage industry founded in 2007 and valued at about $4 billion.

‘Burning Question’

“There’s a burning question about the collateral effects,” said Andrew P. Bridges, a partner at law firm Fenwick & West LLP, which worked for Megaupload on an unrelated case. “I think the copyright industries are hoping to put cyberlockers out of business through intimidation.”

New Zealand police say they found Dotcom in the mansion’s panic room with a shotgun at his side. Dotcom was denied bail on Jan. 25, although his lawyers are appealing, and faces extradition to the U.S. He couldn’t be reached for comment.

Megaupload’s U.S. lawyer, Ira Rothken, has compared Megaupload to YouTube and says the government is overreaching.

“You have to balance the harm to copyright holders against the harm to society that comes from this terrible impact on the Internet infrastructure,” he said.

Other companies that specialize in cloud storage are distancing themselves from Megaupload’s lucrative business model.

“This has nothing to do with what we do,” said Daniel Raimer, a lawyer and spokesman for the Swiss-based RapidShare service.

Amendments Made

Others have made changes to their service in the wake of the arrests. Filesonic.net told users they could gain access only to files they uploaded themselves. Uploaded.to blocked U.S. consumers from its service entirely.

To some extent, this is what Hollywood wants.

“I think this changes the calculus,” says Kevin Suh, a content protection executive at the Motion Picture Association of America. “Maybe copyright infringement isn’t as attractive anymore.”

Recording Industry Association of America Chief Executive Officer Cary Sherman says some services, like Dropbox, are clearly legitimate.

In between Dropbox and Megaupload is a gray area.

In the U.S., the law that balances the interests of content owners and technology companies is the Digital Millennium Copyright Act. According to the law, Internet companies get “safe harbor” and aren’t liable for any copyright infringement that takes place on their sites, as long as they don’t know about it and quickly take down copyrighted material once rights holders ask them to.

Wide Latitude

So far, courts have given technology companies wide latitude under the act. Eric Goldman, a professor at Santa Clara University Law School who specializes in issues raised by new technologies such as cloud computing, says criminal prosecutions may be one way around the limitations of the act, because the “safe harbor” protection doesn’t apply.

“Cloud services have been increasingly confident that they’re protected by DMCA,” Goldman said.

A related worry is that a crackdown on file storage services could scare away users. Megaupload may have hosted pirated content, but it also stored school reports and home videos that are now inaccessible.

“Leaving aside whatever other consequences there may be, there’s a huge problem for customers of the online lockers,” Fenwick & West lawyer Bridges said.

Studio executives say they’re interested only in businesses based on piracy, not legitimate players. “Our goal is to go after the worst of the worst,” Viacom Inc. (VIA) General Counsel Michael D. Fricklas said.

To contact the reporter on this story: Robert Levine through Barrett Sheridan at rlevinson5@bloomberg.net

To contact the editor responsible for this story: Barrett Sheridan at bsheridan3@bloomberg.net

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