By GEOFFREY A. FOWLER
When the U.S. Department of Justice shut down online file-storage company Megaupload Ltd. in one of the largest criminal copyright cases ever, it also cut off legitimate customers like Suzanne Barbieri.
The London-based musician, who performs under the name Beloved Aunt, had used Megaupload since 2009 to send her songs to her producers and record label. She even used it to store the digital versions of her work that she gave away as freebie downloads.
How other online storage companies have responded to Megaupload's closure:
Filesonic Shut down both file sharing between users and an affiliate rewards program
Fileserve Shut down file sharing and a rewards program
RapidShare No change
"If this leads to the closure of all file sharing sites, then I've no idea what people in my position will do," she said. "Piracy hurts artists, but so does this heavy-handed approach of penalizing legitimate users for sharing their own work."
The experiences of Ms. Barbieri and other customers of online storage sites known as "cyberlockers" raise some difficult questions about the government's case against Megaupload, and the rights of legitimate users on those services.
The dramatic, unexpected shutdown of Megaupload—which had 180 million registered users and more than 50 million daily visitors—might have a chilling effect on the growing online storage industry, which some people place in the "cloud computing" business.
"This is really bad news for cloud storage industry going forward," said Julie Samuels, a staff attorney with the San Francisco-based digital-rights firm Electronic Frontier Foundation. "I'm concerned about the users who had no due process, and no notice—and no access to their data."
In its 72-page indictment, the U.S. government argues Megaupload's claims of providing data storage are just a cover story to conduct large-scale theft of copyrighted material.
It alleges Megaupload's software design was not consistent with private data storage or other legal uses, because for most users, the site automatically deleted any data that wasn't popular for downloading, which was usually copyrighted material. In the short-term, it's not clear whether—and how—legitimate Megaupload users will get back their files.
The authorities note Megaupload did inform users on its site that they assumed the risk of losing their files, should Megaupload shut down.
Asked whether any innocent users of the site would be able to eventually recover their data, a law enforcement official said the case was still being investigated and noted the site "clearly warned users not to keep a sole copy of material on the site.''
Even without legal clarity, cloud storage and sharing start-ups, particularly DropBox Inc. and Box.net Inc., have generated huge interest from users and U.S. investors. Those sites tend to have very different functions and business models—focused on long-term, small group or enterprise file sharing— from public sharing sites like Megaupload, which may make them less of a target for authorities.
"This is a serious issue, but I don't think that it is a black mark against the cloud," said Aaron Levie, the CEO of Box.net. As for the notion that authorities can shut down cloud services, "it is up to the user to understand the differences between these services and be thoughtful about where they are putting their data," Mr. Levie said.
Cameron Myhrvold, a partner with Seattle-based venture firm Ignition Partners, said the ongoing Megaupload prosecution "is not a huge inhibitor to investment today," he said, but it does "cause conversations and considerations as people look at these investments."
Megaupload and its founder Kim Dotcom have yet to present a defense to charges in U.S. court, or even settle on a legal team. At a bail hearing in New Zealand, where Mr. Dotcom and three other company employees are in custody, their local lawyer has argued that Megaupload had provided free access to major copyright holders, allowing them to delete files when they identified stolen material. Mr. Dotcom was denied bail Wednesday in New Zealand.
Meanwhile, the Associated Press reported late Tuesday that a U.S. official confirmed that Dutch police have arrested a fifth person in the case.
The facts behind Megaupload's take-down system could be a turning point in the case, said legal experts. A U.S. law called the Digital Millennium Copyright Act offers what's known as "safe harbor" to websites that allow third parties to post content on them—so long as those websites act quickly to take down stolen material when notified by copyright holders.
Megaupload "was built and designed around the concept that it could qualify for safe harbor," said Washington, D.C., defense attorney Jeff Ifrah.
Prosecutors dispute that Megaupload could qualify under safe harbor rules. They say what Megaupload actually did was delete links to copyrighted material when they received a complaint.
The actual content, though, was kept on the site and kept accessible through multiple other links, according to federal investigators. When Megaupload realized that taking down a link could in some cases lead to actual copyrighted material being unavailable, investigators said, the company allegedly decided to create a backup system to make sure there was always at least one more link to such material.
Other popular content-sharing sites—such as Google Inc.'s YouTube and Veoh Networks Inc.—have successfully defended themselves in civil cases by using the safe harbor provisions of the Digital Millennium Copyright Act. Mr. Ifrah said the government's criminal prosecution is "more suitable to the type of steps that the government takes against an organized-crime enterprise dedicated to murder, theft and racketeering."
There are some early signs that the Megaupload shutdown is reshaping the industry.
Popular file-sharing services Filesonic and Fileserve both disabled their sites' sharing capabilities as well as rewards programs that paid uploaders when people download their files. Users can only retrieve files they uploaded personally.
Neither company responded to emails requesting comment.
The smaller site UploadBox.com shut down entirely, replacing its homepage with a note that its file hosting service "is no longer available." It said all files would be deleted from the site on Jan. 30.
Rapidshare AB, one of the first and largest cyberlocker firms, said it hadn't changed any of its practices following the Megaupload suit and isn't concerned about becoming a target for law enforcement.
"The Megaupload raid and the arrests have nothing to do with the business model of file storage. They have everything to do with the alleged misconduct of individuals," said Rapidshare spokesman Daniel Raimer.—Devlin Barrett, Lucy Craymer and Sam Schechner contributed to this article
Write to Geoffrey A. Fowler at email@example.com