Organized Crime and the Software Biz

Do you know the damage to your brand?
Software piracy is not the penny-ante nuisance that it used to be.
Perhaps you've heard how the use of illegally duplicated (or bootlegged) software is on the decline at corporations. But did you know a bigger problem is creeping into the business? Organized crime outfits increasingly are responsible for the manufacture and distribution of counterfeit software, say sources inside federal enforcement agencies and from the software industry. "We've known for some time that organized crime is involved," says Peter Beruk, vice president of the anti-piracy program for the Washington, D.C.-based Software and Information Industry Association.
Counterfeit software, unlike bootleg copies, is manufactured to look like--and often is presented as--genuine product. What's worse, crime organizations are not simply selling their bogus wares on the black market. They're getting counterfeit software into the hands of resellers, who then sell the pirated goods to hapless consumers, Beruk says. Such sophisticated crime outfits, not surprisingly, are difficult to catch. At the same time, the enormous number of sometimes-unwitting software resellers, combined with the proliferation of online auctions, makes it difficult, if not impossible, to keep counterfeit copies out of the hands of unlucky customers.
The problem is truly enormous. In some countries, such as China, Vietnam, Russia and Indonesia, nearly 100 percent of business software is pirated, either counterfeited or bootlegged. But it's not just a third-world problem; one of every four installed business applications in the United States is pirated. Software piracy now accounts for an estimated $11 billion loss per year to worldwide software revenues, according to the SIIA.
The financial cost of lost sales, however, is only the tip of the iceberg. "Software piracy doesn't just threaten revenues," says a spokesman from Lotus Development, Cambridge, Mass. "But it can create significant image problems for the company whose software is being copied."
Unscrupulous dealers have fooled many users into thinking their software is the bona fide item. When counterfeited or bootlegged applications fail or infect their systems, however, users blame software vendors, more so than dealers. "There's a definite danger that the company's reputation might be damaged if a pirated copy is faulty," says Philip Costa, director at Giga Information Systems, Cambridge, Mass.
In the past, most of the worry about software piracy focused on corporate bootlegging. That type of piracy, however, appears on the decline, says SIIA's Beruk. "We are seeing some limited decrease of corporate misuse worldwide," he says, noting how falling prices make software more affordable.
Another reason behind the decline is fear. Fewer corporations are willing to take the risk that they'll be caught stealing. The industry "has pursued a combination of education and enforcement in this area," explains Beruk.
To back up the educational efforts of groups like the SIIA, many software companies now aggressively penalize companies that make illegal copies. "We always make the culprits pay more than they otherwise would have paid," says Batur Oktay, corporate counsel at Adobe Systems, Mountain View, Calif. The company frequently issues a press release naming the culprit company. "It's not pretty to be on the receiving end of that kind of publicity. That's got to hurt their business," says Oktay.
Don't let the decline in corporate bootlegging fool you, however. Person-to-person bootlegging across the Internet is a growing problem. "Web sites around the world are giving away unauthorized copies of our members' software products," says Beruk. And those bootleg copies often are accompanied by "hacker and cracker" tools for defeating protection features built into programs, he says. In the United States, many bootleg sites are run by college students, some of who seem to be competing to see who can offer the most software on their illegal sites.
To discourage that type of piracy, software companies have been working with law enforcement agencies to catch and prosecute particularly egregious offenders. And, due to the scope of the problem, federal authorities increasingly are asking for severe penalties.
Take the example of Jeff Levy, a 22-year-old senior at the University of Oregon. Federal authorities arrested him last August alleging he posted for download thousands of copyrighted software programs, musical recordings and digitally recorded movies on his web site. Under the 1997 federal statute known as the "No Electronic Theft (NET) Act," Levy could receive up to 10 years in prison and a fine of up to $250,000, even though he apparently did not receive any profit from his web site. (Levy could not be reached for comment.)
In the short term, Beruk believes that some highly visible prosecutions and convictions eventually will convince offenders that it's not worth the risk. But he also believes more needs to be done to educate would-be consumers of Internet-bootlegged software. "Many people still think that the value of the software is identical to the value of the medium on which it's reproduced," he says. "The software industry needs to make it clear to consumers that they're paying for the content--not for the physical disks."
Educating customers about counterfeiting, however, may prove an even more difficult task. Consumers often are unaware that they've bought counterfeit software. Sure, some counterfeit software is amateurish, but an increasing amount looks exactly like the real product--even down to the certificate of authenticity.
Federal law enforcement agencies are concerned about the increased involvement of organized crime in the manufacturing of counterfeit software. Software counterfeiting, it turns out, is what some call a "bootstrap" crime--a quick way to raise money to launch more traditional crimes such as drug dealing, loan sharking and prostitution.
"We get a lot of people saying, 'What's the big deal if I buy $100 software for $30?' But that $30 is probably going to a crime lord who may be using it to ship underage Asian girls to work in U.S. whorehouses," says Marcus Frank, a sergeant at the Westminster, Calif., police department and part of a special multijurisdictional task force on organized crime.
Frank recently participated in a raid of a manufacturing plant in Paramount, Calif., that uncovered $56 million worth of counterfeited Microsoft software. "They were about to expand their operations to include Corel products when we busted them," he says. The raid uncovered an organized crime operation, says Frank, noting that just one CD duplication machine found at the factory cost $1.2 million.
No legitimate business wants its industry corrupted by crime lords. So some software companies, most notably Microsoft, have been fighting back. "Over the past 12 to 18 months Microsoft has filed up to 200 civil lawsuits against companies that are in the business of distributing counterfeit software," says Nick Psyhogeos, a corporate attorney at Microsoft. The company also has been vigorously publicizing those efforts, issuing dozens of press releases naming the companies that it's suing.
So far, many of the accused in those lawsuits are not organized crime outfits but small, local resellers. The logic is similar to that of the so-called "drug war," says the SIIA's Beruk. "By going after the 'street dealers' Microsoft hopes to eventually be able to catch the big guys."
Some resellers, however, seem genuinely confused about why Microsoft has targeted them. "Software accounts for less than 5 percent of my total business," says Joe Bingham of Marketing Data, West Valley City, Utah. Microsoft has accused Bingham of distributing counterfeit copies of Windows 95 and components of Office 97 Professional. "It wouldn't make any sense for me to knowingly sell counterfeit software," he says.
Many targeted resellers can ill afford to defend themselves against Microsoft's charges. "I'm only a middleman in a chain of middlemen," claims Daryl LaMonaco of D&F Computers, Roselle, N.J., who allegedly distributed counterfeit copies of Office 97 Professional.
What rankles LaMonaco is the press release Microsoft issued announcing that he and four other New Jersey businesses were accused of piracy. "Microsoft has become judge, jury and executioner," complains LaMonaco, deeply worried that he won't have the cash to defend himself. "They can bury me in paperwork," he says glumly, admitting that Microsoft sent him a warning letter before bringing the suit against him.
Bingham maintains that it's extremely difficult for resellers to find out if the software that they're selling is genuine. "They're claiming that the CDs were not manufactured by them. But how was I supposed to tell?"
Some counterfeit copies of Microsoft products, for example, are so perfect they contain valid certificates of authenticity. Bingham claims he frequently called Microsoft's piracy hotline (1-800-RU-LEGIT) to confirm that his copies were valid and got the go-ahead to sell them because they had valid certificates of authenticity.
Microsoft's Psyhogeos, however, pooh-poohs the notion that resellers like LaMonaco and Bingham might be innocent victims. "In every case we send a 'cease and desist' letter before we bring suit," he says. "These guys know what they're doing." Extensive research goes into each case prior to reaching court, Psyhogeos says. Microsoft, for example, conducts sample purchases. When it finds what it believes is a recurring pattern, it brings a lawsuit.
Microsoft clearly is concerned about the spread of illegitimate copies or counterfeits of its software--software it's spent billions of dollars to develop and market. "We receive upwards of 25,000 new reports of software piracy every year, and we follow up on every one of them," Psyhogeos says.
The company feels so strongly about the issue that it's willing to risk appearing like a bully for going against what some call mom-and-pop operations. To forestall bad publicity and keep the focus on the problem of piracy, Microsoft intends to give half the proceeds from its piracy lawsuits to charitable causes.
Still, the company is choosing a hard line in order to protect customers. Psyhogeos insists that resellers should purchase all of their Microsoft products from a Microsoft-authorized distributor to guarantee that products are genuine. "If resellers have been getting their product from a suspect source, it's their fault if they end up selling a counterfeit and thereby put their customers at risk."
Even if it is the fault of resellers, however, customers hold Microsoft and other software vendors responsible. In many cases, customers only become aware of a problem with their copy when they call the vendor for support. At that point, some customers refuse to believe that their copy isn't a valid copy, simply because it exactly resembles the real thing. "It's very difficult for us to convey to the customer that whatever is being offered is not legitimate," Psyhogeos says.
Even if customers eventually recognize that they bought counterfeit goods, many of them feel the software vendor should support it anyway. And some customers perversely feel that it's the responsibility of vendors to see that their software can't be counterfeited. "It has caused relationship problems when people have looked to us for support when they didn't have a legal, authorized copy," says Adobe's Oktay. "But we have no choice because we can't condone and support pirated software."
When discussing the sensitive issue, Psyhogeos denied that Microsoft is only targeting nickel-and-dime operations or that it's ignoring organized crime. "We do bring cases against distributors and manufacturers," he says. "But these are civil lawsuits whose purpose is to announce that we are taking steps to remove the counterfeit supply from local markets, and to let customers know that they're taking certain risks when they deal with certain resellers."
Microsoft's efforts to clean up retail channels, however, may be in vain. An increasing amount of counterfeit software is moving through an entirely new channel--online auctions, such as those conducted on eBay and Yahoo! A recent search on eBay for the phrase "Office 2000" revealed no less than 340 classified ads promising to provide Office software from Microsoft, Corel and others at prices far below the actual retail cost.
Adobe, for one, is frustrated by the problem. "We get calls all day from people who bought stuff on an auction site and then found out that it wasn't what they paid for," says Oktay with a sigh. "Our research tells us that between 70 percent to 90 percent of the software offered on auction sites is pirated," he says. Many bogus copies, then, get into the hands of legitimate businesses that think they've gotten a bargain.
Interestingly, Adobe finds auction companies haven't been a great help in reducing the flow of pirated software. "We spend a lot of time going to auction sites, trying to get them to pull illegal software sales off their sites," Oktay says. Adobe has asked eBay, for example, to remove software as a category on its site, he says. Oktay claims he was told it was "a big source of revenue for them, so they're not willing to forbid software sales."
EBay, however, denies making decisions about what categories to support based upon the revenue that they generate. "We've never evaluated whether online software sales is a big source of revenue," says Jay Monahan, eBay's senior intellectual property counsel. EBay has removed "hundreds" of auction listings at the request of software companies, Monahan insists. "We are absolutely committed to ending auctions of allegedly infringing software that they bring to our attention."
Ebay, however, lacks the expertise to proactively police its site, Monahan says. "It's next to impossible for eBay to determine what's legal or what's not," he says. He notes how some counterfeit software is so well-manufactured that even software companies themselves have trouble figuring out what's real and what's not.
And therein lies the real challenge for the software industry. Over the long term, the software industry will need to come up with more sophisticated mechanisms for checking the validity of software. Some sources suggest maintaining critical pieces of software code on a web site that must be accessed prior to use of software.
Until then, however, bogus software likely will continue to proliferate, resulting in lost sales, computer viruses, dissatisfied customers--and a weaker corporate image for the companies whose software is being counterfeited. MC
Geoffrey James (www.geoffreyjames.com) is a frequent MC contributor and author of Success Secrets from Silicon Valley (Times Books, 1998).
"A crime lord may use piracy profits to ship underage Asian girls to U.S. whorehouses." --Marcus Frank, police sergeant
"It's very difficult for us to convey to the customer that whatever is being offered is not legitimate." --Nick Psyhogeos, Microsoft attorney