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Do CD distributors rip off musicians?

FBI agents and federal prosecutors are looking into whether millions of dollars worth of CDs have been diverted and sold, cheating artists like Madonna out of royalties and ripping off big music companies.

The concerns have prompted Time Warner Inc., the world's largest media and entertainment company, to examine its own music distribution business for the second time in two years.According to two longtime industry insiders who say they have been interviewed by the FBI, the questions center on whether unscrupulous employees have been misdirecting newly manufactured CDs and selling them improperly for cash.

The problem, industry critics said, is a distribution system that at best lacks adequate controls and at worst is littered with pockets of stubborn corruption.

"They have created an underground cash economy with the cash sales of (CDs) to such an extreme that everyone's getting in on the party," said Lee Hasin, a retired music producer and former owner of Lancer Music Inc. of Philadelphia.

Hasin has made stamping out industry corruption something of a one-man crusade and has sent reams of information to federal investigators.

The most recent investigation puts the spotlight on the music industry for the second time this year. In May, federal investigations into alleged price-fixing in compact disc sales and overseas music videos came to light.

One way the CDs can be improperly sold, Hasin said, is through "one stops," companies that act as middlemen between manufacturers and small music stores.

Here's how it works: Employees at either manufacturing plants or record labels order a certain number of CDs - say 500 - shipped to a distributor as payment for advertising in the distributor's catalog. So far everything's above-board.

Instead of ordering the 500 CDs, however, the employee orders 2,000 and is paid cash for the extra 1,500. The distributor can then sell the extra CDs at a profit, and everyone walks away richer.

Meanwhile, the CDs - known as "cleans" since they are not marked as promotional or discount merchandise - were billed as advertising allowances, so no royalties are paid to the artists. It's also possible the employee might not disclose the cash sale as income for tax purposes.

Investigators would like to determine how prevalent such practices may be in the $9 billion-a-year CD industry. They could leave a long and diverse trail of victims.

In addition to stars like Madonna and Whitney Houston not getting royalty payments, the music companies, their shareholders and taxpayers alike could lose out on revenue from CDs improperly sold.

"There's been a lot of wheeling and dealing in the music business," said Marvin L. Rudnick, a former federal prosecutor who targeted music industry corruption in the 1980s.

Hasin and others contend the improper sale of "cleans" is merely the latest machination of that approach. Both Hasin and Allen Richman, who managed the now-defunct Richman Brothers Inc. and still works in distribution, said they spoke with the FBI about alleged instances of "cleans" making their way into the marketplace.

One of at least two plants investigators are asking about is Time Warner's WEA warehouse in Bridgeport, N.J., according to Hasin, who said he discussed the facility with the FBI and a federal prosecutor. The warehouse distributes CDs for the Warner Bros., Elektra and Atlantic labels.

In 1995, Warner Music Group disclosed that it was conducting an investigation into its music distribution business, which included the WEA warehouse. The investigation turned up signs of wrongdoing, and some managers were fired. Time Warner never released its findings.

In a Sept. 9 letter obtained by The Associated Press, Time Warner's general counsel, Peter R. Haje, said the matter is drawing a second look.

"Time Warner will do a follow-up inquiry to try to find out whether improper practices have continued in our records distribution business and whether the corrective steps taken after the prior investigation have been effectively implemented," he wrote.

Haje wouldn't comment on the letter, which had been sent to Hasin in response to information he provided.

Richman spoke with the FBI instead of appearing before a grand jury in Birmingham, Ala. He said he told them about another CD manufacturing plant, in Huntsville, Ala.

Les Jezuit, president of Quixote Corp., the plant's former owner, said two employees were fired when the plant discovered improprieties involving CDs manufactured for BMG Entertainment, home of the Arista and RCA labels.

"There was an investigation into the allegedly unauthorized diversion of compact discs, and when the situation was brought to BMG's attention, BMG made sure that all appropriate copyright and other royalty payments were made," said Jonathan Liebman, an attorney for BMG.

Adds Jezuit: "We turned everything over to BMG and the FBI, and it's my understanding that the investigation continues."

The FBI and federal prosecutors in Philadelphia and Huntsville wouldn't comment.