I consider this a serious issue for all us game developers and thus have forwarded all our questions to my IP lawyer for official advice. This should clear up the issue a bit.
Until I get the response, here are my interpretations and opinions on US Copyright Law:
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But, you can indeed handpaint a picture of mario and sell it as your own artwork.
I guarantee you that you can't. Remember, the basis of Copyright law is to protect the copyright owners ability to make money off their product and protect the IP reputation. In your example, if you handpaint a character that is clearly based on Mario, then people may come to you instead of Nintendo to buy Mario stuff (hurts Nintendos ability to make money) and based on your artistic skills, people might think less of the Mario character because you drew him poorly (hurts the Nintendo's reputation).
Here's an example from last year on what Nintendo considers infringement:
Nintendo warns Wiki
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This has been done by at least one notorius photographer, and he hasnt been stopped legally.
Just because the original artist decided not to enforce his copyright does not mean that there wasn't infringement. Since a photograph of another photograph is clearly a copy, then this is infringment IMO. If this was used for a newspaper article or educational, it would fall under "fair use" and that is legal.
Beside, here you have clearly contradicted yourself for a photograph of a photograph is clearly a carbon-copy through mechanical means and yet you claim this is not infringement.
Consider this personal example, Matt: You posted hand drawings on the boards a while back. By your reasoning, it would be legal for me to take a photograph of my screen with that picture displayed, crop all or any portion of my photograph so that only your hand drawing shows, transfer this to a t-shirt, and sell this t-shirt with your drawing on it with 100% of the profits coming to me. Doesn't this sound unfair to you?
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You can copy whatever you want and sell it as your own work, as long as you didnt use mechanical measn to make a carbon copy of copyrighted art.
US Copyright Office Infringement FAQ
US Copyright law makes no such distinction about how a copy is made, only that the copy exists.