A $179 million judgment against Fox highlights a potential dark side to big media mergers

Key Points
  • An arbiter ruled Rupert Murdoch's 21st Century Fox defrauded producers and actors of the show "Bones" of millions in lost profit sharing.
  • The ruling highlights the potential conflicts of interest of media vertical integration.
  • While Netflix has simplified accounting by unifying exclusive distribution of programming and content ownership, a profit-maximizing model for hit shows would most likely separate content from distribution.
Rupert Murdoch, Chief Executive Officer of News Corp.
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Rupert Murdoch's 21st Century Fox has been ordered to pay $179 million in damages for engaging in fraud with the creators and actors of TV series "Bones," according to an arbitration ruling made public Wednesday.

The ruling against Fox, one of the largest ever in the entertainment industry, illustrates the messiness and potential for fraud when media companies own stakes in both content production and distribution.

The arbiter, Peter Lichtman, ruled that "Bones" producers and actors were systematically cut out of profit sharing from licensing fees by Fox executives who engaged in "self-dealing. This allowed Fox to boost the value of Hulu with "Bones" content without paying market rate. Fox owned 33 percent of Hulu at the time.

The Hollywood Reporter detailed the various rulings against Fox earlier today.

"What we have exposed in this case is going to profoundly change the way Hollywood does business for many years to come," said John Berlinski, an attorney at Kasowitz Benson Torres representing David Boreanaz and Emily Deschanel, who starred in "Bones." 

Fox plans to challenge the ruling in court, responding that "the ruling by this private arbitrator is categorically wrong on the merits and exceeded his arbitration powers. Fox will not allow this flagrant injustice, riddled with errors and gratuitous character attacks, to stand."

Whether or not Fox successfully challenges the arbiter's definition of self-dealing, the decision highlights potential pitfalls of vertical integration among large media companies -- a phenomenon that's dominated the industry over the last 12 months.

Shuffling expenses as priorities change

Netflix's huge investment in original content, marrying exclusive rights to shows with its streaming platform, has altered the way content creators and actors are paid for their shows.

Instead of selling shows to the highest bidder, creators such as Ryan Murphy and Shonda Rhimes have signed multiyear deals to make programming exclusively for Netflix. This has actually simplified the accounting, as exclusivity clauses eliminate the need to shop shows to the highest bidder. There are also no advertisements on Netflix, removing another possible revenue-sharing conflict of interest.

But when shows run on television and have later episodes on streaming platforms, rights are shared. And when one company owns both the content rights and the distribution platform, as with Fox, Hulu and "Bones," media companies can purposely undervalue streaming rights to boost subscription numbers, instead of trying to sell the show for the maximum possible amount. That hurts the stars and producers who are entitled to a share of the show's profits.

These conflicts could become more common as legacy media companies merge and launch new streaming services to compete with Netflix and other online players.

AT&T's acquisition of Time Warner, which finally cleared regulatory challenges Tuesday when a federal appeals judge ruled the deal could stand, marries an enormous wireless and TV-distribution network with more than $85 billion of content assets, including HBO and Warner Brothers.

Disney's $71.9 billion deal for Fox last year will give Disney a 60 percent stake in Hulu, one of the largest streaming platforms of TV content, in addition to a slew of new programming. Disney is also building a new streaming platform, Disney+, which will house original and existing library content.

As investors value certain higher-growth assets, such as streaming platforms, more than legacy properties, companies may look to shift costs within their empires to boost the value of certain aspects of the business. The ruling against Fox reinforces that companies must be careful to avoid tripping contractual language when they use their own platforms to showcase content.

"Bones" ran for 12 years on Fox and was produced by Twentieth Century Fox Television. It then ran on Hulu for "highly speculative, below-market monetary terms," according to Lichtman.

"The self-dealing analysis is hardly surprising considering that the Fox/FEG executive who negotiated and agreed to the original ad revenue split was also representing Hulu's interests at the time," Lichtman wrote in a 68-page ruling about Dan Fawcett, the president of digital media at Fox Entertainment Group. "The obvious inferences of self-dealing, conflict of interest and lack of any arm's length negotiations leap off the page."

The $180 million ruling against Fox will likely be viewed by content creators as a safety net if they're worried that a messier, vertically integrated world will rob them of their earning potential.

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