In Arista Records LLC v. Launch Media Inc., --- F.3d ---, 2009 WL 2568733 (2d Cir. August 21, 2009), the Second Circuit considered the case of an internet "radio" station on Yahoo called Launchcast. The Second Circuit is the first federal appeals court to rule on the issue.
Launchcast, like Pandora permits listeners to "create" their own radio stations. The Court's opinion does a great job of explaining how such "stations" work and the extent to which consumers' preferences are registered within Yahoo's service. Essentially, consumers have very limited control over the content and have veto power over songs that they don't like.
The court's opinion is a good explanation of both the technology and the legislative history. Noting that federal judges are appointed for life and thus have "varied" understandings of the technology involved, the court endeavored to make the inner workings of Launchcast's technology clear in plain English.
"Interactive service" is defined in the Copyright Act 17 U.S.C. Section 114(j)(7). Webcasting services that are not interactive must pay a statutory royalty set by the Copyright Royalty Board.
Interactive services, on the other hand, must also pay an individual license fee for each song in question to a performing rights society. The reason is that the copyright holder has the exclusive right to "to perform the copyrighted [sound recording] publicly by means of a digital audio transmission" 17 U.S.C. Section 106(6).
The Second Circuit agreed with the appellant BMG that the question of interactivity was a question of law for the court, not a jury question (the trial court put the question to the jury). But the Second Circuit then found against BMG in that the Launchcast service was not an "interactive service" within the meaning of the Copyright Act.
Last Christmas, I showed my mother how to create a radio station on Pandora that played songs like "Charlie Brown's Christmas". She has since become a big Pandora fan.