I'll start off by saying that I'm not a lawyer, but as a member of the broadcast industry I have studied copyright law and how it pertains to music in particular.
I'll start off by describing the law, then work through how it applies to LOTRO and you in a practical sense. You can then decide for yourself what level of copyright infringement you are comfortable with.
If you have any corrections to make, let me know and please cite sources.
Copyright Law in the US: The Basics
Copyright law protects the creator of, well, creative works. When it began it covered only specific kinds of works such as literature, but it has been expanded in the years that followed to include nearly everything. Copyright law protects authors with the following:
-The right to reproduce the work (such as burning a CD)
-The right to derivative works (such as a remix of a song)
-The right to distribute the work (such as selling or giving away)
-The right to publicly perform the work (such as a concert or streetcorner)
-The right to publicly display the work (same as performing, but with pieces such as paintings)
Ah, you may have noticed the big one. "Publicly Perform." You might think that performing copyrighted works is okay, so long as you don't make any money doing it. This is not so. By performing for free, you devalue the work. Simply put, the original author can't make any money performing if other people perform the same work for free.
A lot hinges on whether it could be proven that playing something in LOTRO is a public performance, something that in the real world is usually dependent on the number of people listening.
It could also be argued that by posting ABC files on the internet, you are illegally distributing the work, or at the very least derivative works.
Fair Use
You may have noticed things like small .mp3 samples on websites that sell music, or excerpts of articles quoted in books or websites.
"Fair use" is an exception to copyright law meaning that anyone can reproduce small portions of copyrighted works. Though not always required, it is helpful if you attribute the work when you do so. "Attribution" is a fancy word meaning you cite the original author as the creator of the work.
Parodies are also protected by Fair Use. The Supreme Court defines a parody as "the use of some elements of a prior author's composition to create a new one that, at least in part, comments on that author's works."
What is copyrighted?
Everything, as soon as it is published, whether it be posted on the internet, published in a magazine, played on the radio, whatever.
The author does not need to apply for a copyright if they published it after 1978, though doing so helps prove their case in court if the work is stolen. If published prior to 1978, they do need to have filed the copyright with the US Copyright Office.
A "poor man's copyright" that is used by some authors is to seal a copy of your work and send it to yourself via registered mail, which is timestamped and considered admissable in court. Obviously, you don't open the package until you're in a courtroom.
Public Domain
The "Public Domain" is where works go when they are no longer under copyright. Public Domain works can be used freely by anyone.
-Works published in the US prior to 1978 remain copyrighted for 95 years from the date of publication.
-Works published in the US after 1978 remain copyrighted until 70 years after the death of the author.
-Works of US corporate authorship published after 1978 remain copyrighted for 95 years after publication or 120 years after creation, whichever is shorter.
There are a few other rules, but this is enough to give a general idea. If you have a specific question and you don't think it's covered here, the US Copyright Office can help you.
Fun fact: The Copyright Act of 1976 (which took effect in 1978, obviously) originally protected works for 50 years after the death of the author. In 1998, Disney successfully lobbied Congress to extend it by 20 years, as Mickey Mouse was about to slip into the public domain.
Fun Fact #2: The song "Happy Birthday to You" is copyrighted and will remain so until the year 2030. This is why it is not sung at restaurants such as TGI Fridays, and they instead sing some other birthday-themed song.
The LOTRO EULA (End User License Agreement)
Now, with all these laws protecting the author of works, any idiot can assume that Turbine did some covering of their own. They did:
"...Content created by you must not: (a) infringe any copyright, trademark, patent, trade secret, or other proprietary right of any person or entity;..."
So not only are they (in theory) protected, they could even suspend or ban you for inputting copyrighted material to protect themselves. Not that they need the excuse, as they can ban you for any or no reason at any time. Until it starts happening however, I wouldn't worry too much about it.
So wait, I can't play any copyrighted works?
Technically speaking, no. Are you likely to be sued for it? Basically, not a chance in hell. (though I assume no responsibility if you are, *cough* *cough*)
Remember the case where Marvel sued NCSoft over City of Heroes? The lawsuit stated that NCSoft was responsible for the copyright infringement being perpetrated by the players. You see, players were using the robust hero creation system to recreate approximations of copyrighted characters.
The point is, Marvel didn't sue each player. It would have been a waste of time. They sued NCSoft, and settled out of court. The conditions weren't released, but it is presumed that NCSoft paid Marvel some money to make the problem go away quietly, though chances are good the lawsuit would have been defeated (details).
It isn't too much of a stretch for the RIAA, ASCAP, or BMI to try to sue Turbine, but that's between them. And there probably isn't much of a case.
On the other hand, the RIAA is a bloodthirsty animal when it comes to illegal music downloading. That sort of thing is a lot easier to prove than what songs you play in LOTRO, however. They would have to know when you did it and your account name, and lean on Turbine to release the logs.
Posting copyrighted material on the forums, however, is easy to prove (if Turbine cooperates). Not all ISP's have rolled over for the RIAA and given them their logs, whether Turbine would do the same is unknown.
Would-be composers: Who owns the work you create on LOTRO?
Here's another section from the EULA:
"...If and to the extent you are deemed to have retained, under applicable law, any right, title or interest in or to any portion of the Content, you hereby transfer, grant, convey, assign and relinquish solely and exclusively to Turbine, in perpetuity to the extent permitted by applicable laws or for the duration of the legal protection afforded to the Content...To the extent permitted under applicable laws, you hereby waive any moral rights you may have in any and all Content..."
(emphasis mine)
This is where it gets muddy. It sounds like Turbine would like to claim whatever rights to your work that they can, but precedent in these types of cases is limited. To be safe, I would advise against playing anything in LOTRO that you plan to copyright and sell. You do retain certain rights no matter what the EULA says, but it's best to avoid a battle.
To clarify what the EULA means by "the Content," I'll make another quote from earlier in the same section:
"As part of your Game experience, you may be able to input language and upload content to the Game, our servers and similar areas which allow you to communicate with others in various forms, such as in the selections you make for playing the Game (for example, character names, in-game (text or voice) conversations, broadcast announcements, etc.) and in chat channels (text or voice), and to create and modify your user interface, characters, character names, game play and the like (collectively, the "Content")"
(again, emphasis mine)
So we can see by "Content," they in fact mean what the player inputs and creates. Though it doesn't specifically say player music, it could fall under "game play."