PEOPLE

PEOPLE'S REPUBLIC OF CHINA

SUMMARY

On February 26, 1995, the U.S. and the People's Republic of China entered into a landmark agreement containing three substantial Chinese commitments. China pledged:

•first, to undertake aggressive and continuing enforcement actions and to impose deterrent sanctions against the epidemic of piracy that caused over $850 million in losses to U.S. copyright-based companies in 1994;

•second, to restructure its prosecutorial, administrative and border control systems to control the production of pirate product in the future; and,

•third, to begin to open its market to the music and recording, motion picture and publishing industries for the first time.

The agreement was specific, complete, transparent and enforceable. It was welcomed by the industry, press and the public as a triumph of U.S. trade policy. It met the key objectives of the U.S. government and the affected private sector and, if implemented fully and quickly by the Chinese government, would allow these industries, for the first time, to enter this vast potential new market with a strong opportunity to achieve success and profitability. Today, one year later, some aspects of the 1995 agreement have been implemented; but China's principal commitments remain largely unfulfilled.

On the positive side of the ledger, China has established the various enforcement task forces required by the agreement, and a significant number of raids have been conducted in major cities against retailers selling pirate product openly. While many of the agreement deadlines were missed during this process, the task forces now appear to be in place. Other aspects of the agreement have also been fulfilled. Customs regulations have been promulgated, though they still remain deficient in a number of respects. We understand that many of the interim deadlines with respect to controlling the output of the CD plants have also been met.

Unfortunately, however, the principal obligations underpinning the agreement have not been carried out. First, the infamous CD plants are still operating and producing pirate product in the millions of units -- pirate music CDs, video CDs of U.S. feature films, and CD-ROMs containing compilations of business applications, entertainment software, and multimedia products of all types. While so-called plant closures and "sanctions" of unspecified scope and severity have been announced, in many cases they cannot be confirmed. Plants that were closed have soon reopened and, to the best of our knowledge, are continuing to produce pirate goods unabated. Indeed, last fall, months after the agreement went into effect, pirate production in the plants had actually gone up to 45 million units. During the latest talks in Beijing in February 1996, USTR negotiator Lee Sands was told that arrest warrants had been issued for a number of plant owners but no one was yet in custody. While this is certainly hopeful news, actual arrest, punishment and a confirmable halt in production is the only possible litmus test of whether there has been compliance.

Second, a key to whether the government is serious about eradicating piracy is whether it imposes deterrent penalties on violators. To date, IIPA has only been made aware of one successful criminal prosecution for piracy of U.S. copyrighted works that has resulted in a high fine or jail sentence -- a reported 9-month jail term in Guangdong Province following a major seizure of CDs from a pirate distributor. This is a dismal record and hardly in compliance with China's commitment to use its criminal law to deter piracy. The record of administrative enforcement by the National Copyright Administration (NCA) and by the State Agencies for Industry and Commerce (SAIC) has been improving, but penalties, particularly against major infringers, are still woefully low. We know of no instance where either of these agencies have referred serious cases for prosecution under the criminal provisions of the law, as is required by the agreement.

Third, border control systems, enforceable by Chinese Customs, have only just begun to look promising with the advent of new regulations and a recordation system. But the rules and administrative machinery are only at the beginning stage of development and appear to require registration of each separate copyrighted work (including updates and later editions) before Customs will take action. Actual seizures have been far too few to deter the massive and blatant export of CD and videogame cartridge-based product emanating from pirate factories throughout China.

Fourth, even if piracy were halted tomorrow, the copyright industries are, for the most part, excluded from the market by barriers which the Chinese promised to remove. Under the Agreement, quotas were to be completely removed, but they informally persist in both the motion picture and recording sectors. Detailed commitments on joint ventures have not been fulfilled; the regulations authorizing them are stalled in political and bureaucratic limbo. As a result, U.S. record and film companies have not been permitted to establish operations in China, a development that was to have occurred immediately under the terms of last year's agreement. New barriers have been instituted. New investment guidelines have put the film industry in a prohibited category, preventing investment in new theaters that China's own film industry needs in order to revive. Taxes on the theatrical and video business are close to being confiscatory. While MPA believes progress is being made, these companies are still not meaningfully in the market.

In short, despite improvements in the retail area, and in areas which have proven less politically difficult for the Chinese government, the agreement's major commitments are far from being met. It would not take long for China to meet them. The issue is political will. China must:

•publish the joint venture regulations and repeal informal quotas and taxes;

•shut down pirate production at plants manufacturing pirate CDs, CD-ROMS and videogames, and arrest and prosecute owners;

•begin, and publicize, criminal prosecutions of major distributors of pirated material;

•seize major export shipments coming from CD plants and plants manufacturing pirate videogame software.

Unless major steps such as these are taken immediately, IIPA and its members see no alternative but to ask the U.S. government to preserve the credibility of this entire process by announcing sanctions in conformity with U.S. Trade Law. China has been on the Watch List and under the monitoring provision of Section 306. It should be returned to the Priority Foreign Country category. The integrity of our agreements demands this action.

ESTIMATED TRADE LOSSES DUE TO PIRACY IN 1995

Motion Pictures: $ 124.0 million

Sound Recordings and

Musical Compositions: $ 300.0 million

Computer Programs:

Business Software N/A

Entertainment Software: $1,286.0 million

Books: $ 125.0 million

TOTAL LOSSES: $1,835.0+ million

HISTORY

After USTR placed China on the Priority Watch List in both 1989 and 1990 to encourage it to commence a law reform process, China passed a new copyright law in September 1990 which became effective for domestic works only on June 1, 1991. That law was not compatible with the Berne Convention and, as a result of the high and growing losses due to piracy, USTR named China a Priority Foreign Country in April 1991. In January 1992, China and the U.S. settled the resulting Section 301 action by entering into a Memorandum of Understanding (MOU) which committed China to adopt Berne-compatible regulations to its copyright law and to join the Berne Convention effective October 15, 1992 and the Geneva Phonograms Convention effective June 1, 1993. U.S. works became fully eligible for protection under the MOU on March 17, 1992 and China was then placed on the Watch List in April 1992.

On September 30, 1992, China's Berne-compatible regulations went into effect. It joined the Berne Convention effective October 15, 1992 and the UCC effective October 30, 1992. China remained on the Watch List in 1993 with IIPA and USTR pushing for passage of legislation to make copyright piracy a criminal offense, as well as for enforcement. On November 30, 1993, Ambassador Kantor elevated China to the Priority Watch List due to China's failure to enforce its law. In February 1994, IIPA reported significantly increased trade losses, up to $823 million for 1993. Due to the absence of criminal penalties and a total lack of enforcement, USTR named China again as a Priority Foreign Country in June 1994. Though the National People's Congress adopted a criminal penalty provision for copyright piracy in July 1994, it was not until 1995 that it became effective when an interpretive ruling was issued by the Supreme Court. Meanwhile, U.S. trade losses continued to mount. On February 4, 1995, the U.S. government announced $1.08 billion in retaliatory tariffs to compensate for trade losses due to piracy in China. The imposition of these tariffs was narrowly averted by the U.S.-China IPR Agreement on February 26, 1995. As a result of the Agreement, the second Section 301 case against China was terminated, and it was made subject to monitoring under Section 306, and, on April 30, 1995, moved to the USTR Watch List.

PIRACY, ENFORCEMENT AND MARKET ACCESS

Throughout 1995, IIPA members established their enforcement programs in China, conducted training seminars and generally worked with the Chinese enforcement task forces, where possible, to assist in implementing the IPR Agreement. The record has been one of slow progress and considerable frustration.

Sound Recordings and Musical Compositions

The RIAA's top priorities during the Agreement's implementation were to have the Chinese government assert effective control over pirate production in the CD factories. It sought to ensure that all molds in all factories were SID-coded, and that the title verification obligations in the Agreement were fully implemented. While the Chinese government has recently announced that all molds now have the SID code and that NCA inspectors (under the overall supervision of the Press and Publications Administration (PPA)) have now been placed in all the PPA-regulated factories, it remains unclear whether production of pirate product has dropped from the high of 45 million units in August 1995. RIAA's international affiliate, IFPI, set up a title verification system, but has received only a very few title verification requests despite Chinese commitments to implement the system, flowing from a structural gap in the system under which only record companies, but not CD plants themselves, are required to present copyright information. This is a direct violation of the terms of the IPR agreement.

Music CDs produced in China continue to flood Hong Kong, and pirate Chinese product continues to be seized in Europe, in Latin America (transhipped mostly through Paraguay), in the Middle East and by U.S. Customs on the west coast. In December 1995, IFPI was forced to close its Guangdong office (which has yet to reopen) due to death threats from thugs employed by one of the larger and more powerful CD plants. While these threats were not condoned by the Chinese government, it is responsible for the climate that led to them through its failure to take effective action to shut down pirate production and legitimize the industry.

Estimated trade losses in 1995 were $300 million, consisting of estimated losses of $40 million in the domestic market and $260 million due to worldwide exports. While the major problem for the industry is pirate CD production, it should not be forgotten that the domestic market is primarily cassette and is virtually 100% pirate. Nothing has been done in this area.

In late December 1995, the Chinese government announced the closure of four CD plants for manufacturing pornographic video CDs, pirate CDs and CD-ROMs. This has a positive sign, although it is unclear whether these plants remain closed. A fifth plant also had its trading license withdrawn following complaints by IFPI, and a sixth plant had molds seized, pressing equipment sealed and senior management arrested -- the latter a first in China. IIPA does not know what else has happened to these plants. It is very difficult to confirm government reports of closures. Moreover, it remains unclear whether these actions were really motivated by the government's commitment to stop pornography -- a capital offense in China. The real test will be whether these actions are taken when pornography is not involved.

The recording industry continues to press to no avail for implementation of China's market access commitment to permit production joint ventures that may engage in all relevant record company activities permitted under the agreement (e.g., including signing of local artists, original production and reproduction, advertising and promotion, but excluding distribution). As noted above, the regulations must be approved before this can occur. The failure to issue these regulations puts China in clear violation of its written commitment in this regard. RIAA and its members continue to press for further liberalization and seek to ensure that liberalization in the area of distribution will be an element of China's WTO accession. Even if piracy were halted tomorrow, without improved market access as promised, U.S. companies would see little benefit.

Motion Pictures

Following shortly on the heels of the IPR agreement, the Chinese government announced the temporary closure of the famous Shen Fei Laser Optical Co. factory which had been producing and exporting pirate copies in LD format of thousands of U.S. feature films including those just released theatrically. Reportedly Shen Fei remains clean and its owner is actively seeking legitimate licenses from U.S. companies. Unfortunately this hopeful sign was not repeated with other plants. New evidence was uncovered that many plants are now producing video CDs or placing full feature films on CD-ROM, mostly for export. This new phenomenon has already impacted other markets in Asia and, if not controlled very soon, could blight the prospects for the new market for digital video disks and players, due to come out later in 1996.

Video piracy in China remains at 100%, but there have been hopeful signs in the theatrical market, where China Film has distributed a few films under revenue-sharing arrangements with U.S. studios. The exhibition of these films have been mutually beneficial to the U.S. and China, and MPA seeks a liberalization of the informal quota of ten films per year under revenue sharing arrangements. VCDs can be found in many of the major cities but the main video piracy problem in China is videocassette piracy.

There is also widespread public performance piracy in hotels, clubs, mini-theaters and even government facilities. In another positive sign, the government just recently announced the closure of 5000 mini-cinemas that use pirate product for public performance screenings.

Broadcast piracy is also a problem. There are over 680 TV stations in China, all state-run, which broadcast to 240 million TV households. The great majority broadcast U.S. programs without a license. Often this is justified via a "false license" from a Taiwan, Hong Kong or Thai "distributor."

There are also approximately 740 cable systems in China, serving 30 million households, with hundreds of additional private systems serving apartment complexes, factories, government ministries etc. All these systems regularly use pirate product.

Unlike the unexplained experience of the recording industry, MPA and AFMA have had good response to their title verification system. NCA has made over 2000 requests for verification of rights which have been promptly responded to. Ninety percent of the requests that NCA has passed on to MPA and AFMA for verification of claims of duplication and distribution rights have been determined to have been based on false license agreements. It is unclear, however, whether this system has had any impact on pirate production by the CD plants, or on public performance piracy.

In 1994, MPA commenced two civil cases in the Beijing IPR court to test the viability of the enforcement system. These cases continue to languish in the court. However, MPA has brought a number of cases before NCA with better results. NCA has taken action, as of December 1995, in 10 cases, involving 24 titles, and has issued fines totalling about $45,000. Because the maximum fine that NCA can give is only RMB 100,000 (about $12,000), it is questionable that this will have a deterrent effect on distributors and manufacturers.

MPA investigators continue to pursue cases, including pirate distributors and factories. Results in Shanghai, where enforcement has been by far the best in China, have been particularly noteworthy. From August through December, MPA investigators working with the local Copyright Administration, the local AIC and the Bureau of Public Security conducted 9 raids and seized over 35,000 VCDs. Thirteen persons were also arrested during these raids by the Bureau of Public Security. This has had a good effect in the Shanghai market and shows what can be done if aggressive action is taken. Unfortunately, IIPA has no information on what happened to the persons arrested or whether any of these cases were prosecuted under the criminal laws or even under administrative regulations. Despite these isolated successes, the record -- one year later -- still shows no criminal prosecutions for video piracy, and only one fine by NCA at the RMB 100,000 level.1995 losses due to piracy in China are estimated at $124 million.

Market access barriers also hamper development of the Chinese market. Taxes in the theatrical area total over 50%; in video, over 75%. Formation of joint ventures, as promised in the IPR agreement, is not yet possible. Recently announced investment restrictions prevent investment by U.S. companies in theater construction. MPA estimates that the combined impact of these and other barriers results in a loss of an additional $80 million.

Computer Programs

Entertainment Software

Piracy of computer games for PC and Mac formats and of videogame software for cartridge and CD consoles, is rampant in China. The CD plants routinely produce compilations of games on CD-ROM and on other CD formats, and ship them for sale within China and for export. Piracy in China of cartridge format games (many created by U.S. software firms) accounts for a high percentage of the overall world market for game software. The factories that assemble the game software (and infringing game consoles) are well known to the Chinese government but, like the CD plants, have been virtually immune from punishment by the Chinese authorities. These factories are reported to be joint ventures with Taiwan businessmen and, since China does not produce the semiconductor chips which contain the game software, it appears that virtually 100% of the infringing product is imported from Taiwan for assembly and re-export from China. Some of these factories, such as "Little Bawang" and "Tianjin New Star Electronic Co." are thought to be the largest producers of pirate videogame product in China.

IDSA reports that over 10,000 stores sell its members' game software in Beijing alone and that over 50% of Beijing families own console hardware. If this is indicative of the size of the Chinese market, the illegal revenue generated by these factories, their distributors and retailers throughout China must be staggering. Extensive attempts to control the market for this product have proved frustrating and so far unsuccessful. Raids run by the AICs in March in Beijing, August in Shanghai and November in Guangzhou and Dongshan netted thousands of cartridges and chips containing infringing software, but resulted in only small fines and revocations of business licenses of some retailers. Despite repeated urgings, it does not seem that these raids have led to further actions against distributors and factories.

For example, a Taiwan-owned factory, Bel-Sonic, in Shenzhen, is suspected of producing 60,000 units per month of infringing Nintendo product. In an action against Bel-Sonic for patent infringement, a fine of only $2,500 was levied against a woman who signed the lease for the premises, not against the company itself.

The IDSA estimates losses in the internal Chinese market due to piracy of both CD and cartridge-based game software owned by its members at $640 million in 1995. Loss estimates for exports of this product for sale in Asia and throughout the world are $646 million. Exports of console and PC-based entertainment software have shown up all over the world, including even in the small country of Paraguay where the product is shipped for re-export to the entire Latin American market. Total losses due to piracy of videogame and PC-based software in China are therefore $1.28 billion in 1995.

To stem the tide of entertainment software piracy in China, the IDSA and a number of its member companies have recently joined BSA and some of its members in forming the Alliance Against CD-ROM Theft (AACT), which will act on behalf of all its members in undertaking direct enforcement actions throughout Asia. AACT was announced on January 16, 1996.

The industry also suffers from a number of market access barriers. There is a 50% tariff on videogame product, making it virtually impossible for legitimate product to be sold at realistic prices in China (and further spurring massive piracy). Attempts to invest locally have always been coupled with severe export performance requirement -- from 60% to 100% -- that make it impossible to serve the local market with legitimate product. These barriers effectively turn over the world's largest potential market to Chinese pirates.

Business Software

Piracy of business software in China is also growing. The CD plants have significantly increased their output of compilations of highly valuable U.S. software, reported for the first time in last year's IIPA submission. BSA's enforcement activities have concentrated on the AIC's and on bringing civil cases against retailers. The results have been less than encouraging. AIC raids have been satisfactory but to date we have no report of any fines being levied against the infringers. Remarkably, the civil cases have fared better. In a December decision in the Beijing IPR court, the Beijing Juren Company was adjudged to have infringed BSA member software. The case was given major publicity. Unfortunately, the damage part of the case has yet to be decided, though a decision is expected shortly. BSA has also recently filed 14 new civil cases against 6 organizations in the Chengdu Intermediate Court and is awaiting movement in these cases.

BSA has also sought to encourage criminal prosecutions against major infringers raided by the AICs. The IPR Agreement specifically provides that the administrative agencies are supposed to routinely refer serious cases to the prosecutors for criminal prosecution. This has yet to happen, despite repeated requests. To add insult to injury, even when BSA has itself referred these cases, prosecutors have routinely turned them down, indicating their lack of interest or relying on an erroneous interpretation of the criminal provisions. Thus despite the fact that these seizures have involved CD-ROMs loaded with tens of thousands of dollars of infringed U.S. business software, prosecutors refused to prosecute, valuing the cases at the street price of a few dollars.

Literally tens of millions of dollars of pirate CD-ROMs have been exported from China through Hong Kong, flooding that small market with illegal product. BSA has fought valiantly to stem this tide and has generally gotten good cooperation from the Hong Kong authorities. However, despite numerous meetings with Chinese Customs authorities, there have been virtually no seizures of this product by Chinese Customs.

Like the other copyright industries, BSA has been active in presenting enforcement and other training seminars whenever they are requested. The association is willing to do more, but expects the Chinese government to do its part: take action against the CD plants, and seize the massive shipments of product leaving China to disrupt legitimate markets worldwide.

BSA has also pressed the Chinese government to make good on its commitment to purchase legal software within government ministries. In the year since the IPR Agreement, there has been virtually no progress in this area. In the same vein, the association has sought to work with NCA on title verification on CD product as promised in the Agreement. Again, after almost a year, its proposal has not been approved and not a single title verification request has been processed.

BSA is in the process of compiling its 1995 loss data, which is unavailable at this time. It will be made available as soon as possible.

The industry is also concerned about the impact of the joint venture regulations and views this as a serious market access problem. The Chinese government had classified "the development and production of software (including computer and communication software etc.)" as an encouraged industry, without limitation as to type of foreign investment vehicle. Instead, the government is now using the IPR agreement's joint venture language, to impose a new joint venture requirement on the U.S. and other foreign software industries. To make matters even worse, as noted above, these regulations have not been issued, in violation of the IPR Agreement.

Books:

Lack of adequate market access and high piracy levels continue to make it very difficult for U.S. publishers to do any significant business in China. English language training (ESL/ELT) texts continue to be openly available in pirate editions in markets and stores throughout China. Unauthorized translations continue. One of two civil suits in the Beijing IPR court has been settled for a moderate sum, providing some deterrent against piracy. However, the growth of CD-ROM pirate production and export from China has overwhelmed many of the important new markets for electronic publishing product in Asia. To stem this tide, the largest U.S. publisher, Simon & Schuster, has joined the Alliance Against CD-ROM Theft (AACT) in January 1996. AAP has also commenced investigative work in China looking toward the filing of additional criminal and administrative actions.

Losses due to piracy of U.S. tradebooks, textbooks, journals and electronic products are estimated at $125 million in 1995.

AAP member publishers are also concerned about China's failure to issue the new joint venture regulations, which, if done correctly, could assist these companies in entering the Chinese market in a more meaningful way.

COPYRIGHT LAW AND RELATED ISSUES

Under the 1992 MOU, China committed to bring its copyright law into full compatibility with the 1971 text of Berne "within a reasonable time." China now operates with a two tier system of protection: Berne levels of protection for foreign works (under the regulations approved in September 1992), and lesser protection under its law and regulations for Chinese works. While this system has not, to date, impacted adversely on U.S. copyright owners, it has been more than 4 years since this commitment to amend its statute was made. China should be urged to meet this commitment.

IIPA is also concerned with the criminal penalty provisions adopted in July 1994. They remain ambiguous in a number of respects, and penalties, particularly fines, remain too low to deter the kind of large scale piracy taking place in China. Methods for calculating the economic harm inflicted by piracy -- an important factor in prosecutorial decisions -- should be specified as based on the value of the infringing product in the legitimate market, not its street value in the pirate market.

Finally, administrative remedies should be strengthened. Minimum fines should be fixed depending on the size of piracy and maximum fines should be lifted significantly.

* * * *

As the above discussion demonstrates, China is a long way from living up to its obligations in the February 1995 IPR Agreement. The U.S. government must not permit the Chinese government to undermine this agreement by piecemeal and minimal compliance with isolated provisions. As was so well said by James Shinn of the Council on Foreign Relations in a commentary article in the February 18 Washington Post (p. C4):

Credibility works both ways; what sense does it make to negotiate trade agreements with China if they won't be enforced? It is laughable to hear excuses from Beijing that they can't control the 50 pirate CD factories. If they were turning out thousand of copies of the BBC documentary on the Tiananmen Square protest -- rather than bootleg copies of "The Lion King"-- the factory managers would be sharing a cell with other dissidents in a heartbeat.

IIPA and its members believe that the time to act is now. The plants must fully cease pirate production now. The other major elements of the agreement must be put in place now. Otherwise, the U.S. should initiate a sanctions process -- now.