News Corp.’s U.S. Hacking Problem

There was nothing friendly in the message coming over the fax machine to News Corp. chief financial officer David DeVoe, CEO Rupert Murdoch’s right-hand man. On March 3, 2004, famed investor and insurance magnate William Berkley sent the confidential fax to DeVoe. The subject: computer hacking and other allegedly anticompetitive behavior by a News Corp. subsidiary against Floorgraphics, a New Jersey–based in-store-advertising pioneer in which Berkley was a major investor. “We have just discovered evidence that our proprietary and password-protected computer files of past, current and upcoming floor ad programs has been breached by [News Corp. subsidiary] News America [Marketing], as identified by their IP address,” Berkley’s fax read. “It appears News America acquired inside knowledge of our systems and passwords through some sort of corporate espionage.”

The computer breach was part of what Floorgraphics would later say in federal court was a broader attack by News America Marketing that also included efforts to swipe its clients and destroy its reputation while claiming its market share and driving it into the ground. And Floorgraphics wasn’t the only target. The News America strategy, detailed in court documents, was part of a broader, multiyear attempt by News America and its CEO, Paul Carlucci, to dominate the entire emerging market for in-store graphical ads, which include shelf-mounted coupons and floor decals: “A deliberate and malicious campaign,” Floorgraphics alleged, “so that News [America] could have exclusive control of all major in-store marketing programs.”

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The revelation that News Corp. was informed seven years ago of allegations of computer hacking and other anticompetitive practices by a minor U.S. subsidiary comes at an inopportune time for Murdoch. The House of Commons and the British police are conducting widening probes into phone hacking and bribery by his British newspapers in their campaign to scoop the competition. Most recently, Scotland Yard expanded its investigation to include computer hacking as well. And the U.S. Justice Department has opened a probe into News Corp., including a look at the hacking allegations Berkley warned News Corp. about. The wider investigation, a government source tells TIME, will explore whether the Floorgraphics case is an isolated one or if it “fits into a larger pattern of behavior.”

Floorgraphics was a classic American start-up. The company was launched in 1996 in Cherry Hill, N.J., with seed money from Berkley’s private investment fund. With brothers George and Richard Rebh at the helm, the company pioneered the idea that decal ads attached to supermarket floors would lure shoppers to products on nearby shelves. Court records show the company started in donated space with a handful of employees, who sometimes slept in the office at night. It brought in less than $1 million in fiscal year 1997, but by June 2001, Floorgraphics was hauling in more than $55 million. In 2002, Inc. magazine named it the 39th fastest-growing U.S. company. And it was aiming high: advertisers spend $542 billion on all kinds of in-store marketing, according to a May 2010 figure in Ad Age.

In the 1990s, News America was mostly in the business of selling coupons called freestanding inserts, or FSIs, in Sunday newspapers. But in 1997 it bought ActMedia, the dominant player in in-store marketing, a profitable niche that included traditional point-of-purchase advertising like placards as well as novel techniques like using shelf-mounted coupons.

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In charge of News America was Paul Carlucci, 64, who had risen from ad sales at the New York Daily News to senior executive positions at major retailers such as Caldor and R.H. Macy. Carlucci has been a member of Murdoch’s executive management committee since 1996. A 2005 Forbes article about his business style starts by saying he “takes no prisoners.”

Floorgraphics’ trouble with News America began in July 1999 at a lunch meeting between Carlucci and the Rebhs at a New York City restaurant. According to the Rebhs’ account in court, he told them he was thinking of expanding into their market: “I’ve always liked floor advertising,” Carlucci said. Conversely, if they wandered into his turf, he indicated, “I will destroy you.” He continued, “I work for a man who wants it all and doesn’t understand anybody telling him he can’t have it all.” The Rebhs would not comment for this article, citing a nondisparagement agreement with News America, whose attorney, Lee Abrams, acknowledged in court that the lunch occurred but denied Carlucci’s threat.

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Floorgraphics charged in its legal complaint, “In the ensuing years, News [America] employed numerous illicit tactics in a prolonged and concerted effort to destroy [Floorgraphics] through illegal, anticompetitive and unfair business practices.” Floorgraphics alleged that News America threatened and tried to bribe customers to drop the company, sometimes offering “large payments” to induce them to do so, court records show. Carlucci’s operatives, according to the complaint, yanked Floorgraphics ads from stores to replace them with News America ads. And in 2001, then News America president Dominick Porco sent a letter to Floorgraphics’ clients claiming (falsely, Floorgraphics argued) that the company hadn’t installed half the ads clients paid for. “At News America Marketing, we operate differently,” it read. “We take field execution extremely seriously.”

Floorgraphics fought back, telling clients not to be put off by News America’s behavior. But finally, in January 2004, a major client called with a surprising question. Officials from the J.M. Smucker Co., the Ohio-based food giant, asked the Rebhs how News America knew about an upcoming ad program that should have been confidential. The Rebhs’ tech people looked at their site and discovered it had been hacked. “It would give a competitor a critical piece of information in computing, in figuring our media revenues,” George Rebh said in court about what News America learned from its computers.

The Rebhs hired Luke Cats, a former cop, to do a forensic analysis of their systems. Cats produced a report, later entered as evidence in court, showing that News America had hacked in 11 times from October 2003 to January 2004 and had access to “every prior advertising campaign … Floorgraphics’ list of customers, and information about ad campaigns, proposed graphic designs and installation strategies that had yet to be made public.”

At first, Floorgraphics hoped to get federal prosecutors interested in investigating a possible computer-fraud case. Two FBI agents visited the company in 2004 to look into the hacking incident. They reported their initial findings to the U.S. Attorney’s office for the New Jersey District, in Newark. That office, then run by current governor Chris Christie, passed on the criminal case. Instead, Floorgraphics went to civil court, suing News America for damages associated with a raft of anticompetitive acts.

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In court, News America admitted to the computer hacking but downplayed it as a minor transgression, probably by a rogue individual. It also blamed the victim, saying Floorgraphics’ flimsy website security was asking to be hacked. “Let me tell you that it wasn’t very well protected,” Abrams, the News America attorney, said in court about Floorgraphics’ website. As for the other allegations, News America denied anticompetitive behavior and claimed that Floorgraphics couldn’t take sharp-elbowed competition. “This company is involved in lots of industries with multiple competitors, and it succeeds by competing fairly, by working hard and building better products and trying to reduce its costs so that it can lower its prices to its customers,” Abrams told the court.

Floorgraphics was not alone in its suspicions about News America, however. During the same period, other, bigger News America competitors had similar complaints. In 2004 a shelf-edge-advertising company, Insignia, sued in a Minnesota federal court, alleging that News America was threatening and bribing Insignia’s clients and wrongly disparaging the company. In late 2006, Valassis Communications, which produces shelf coupon dispensers and newspaper coupon booklets, alleged similar abuses by News America, including “coercion” of clients. In neither case was computer hacking alleged.

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By 2007, News America controlled as much as 90% of the in-store advertising business, according to FORTUNE. It generates almost $1.2 billion in annual revenue–only a fraction of the nearly $33 billion in sales for Murdoch’s conglomerate–but historically has had some of the highest operating margins at News Corp. In 2009, News America offered to buy Floorgraphics for $29.5 million as long as Floorgraphics agreed to drop the case and sign a nondisparagement clause. In 2010, News America settled with Valassis for a colossal $500 million, virtually wiping out its revenue for the year. Finally, in February, News America settled the Insignia case for $125 million and signed a 10-year exclusive agreement with the company to sell signs.

News America’s actions, reported in July by David Carr in the New York Times, might not represent much more than overzealousness in a competitive market if taken individually, say antitrust lawyers and government officials. Commercial computer hacking is illegal under the Computer Fraud and Abuse Act and other statutes, but prosecution requires solid evidence of harm greater than $5,000. Taken together, however, the company’s tactics start to resemble a strategy to dominate a market, which may violate the law. The feds are also trying to determine whether the Floorgraphics hack was an isolated act or part of a pattern of strong-arming, which could be illegal.

A News Corp. spokeswoman, Suzanne Halpin, said News America Marketing conducted a “thorough investigation” into the Floorgraphics computer hacking in 2004 but was unable to identify the culprit because of the “dynamic IP address involved, to which hundreds of individuals had access.” News Corp. declined to release the results of that investigation to Time. Halpin also declined to say whether Murdoch learned about the 2004 hacking allegation at that time. “This is the only instance we are aware of,” she said when asked about any other hacking. News America Marketing “condemned this conduct, which is in violation of the standards of our company.”

News Corp. declined to say when DeVoe and Carlucci became aware of the hacks. A handwritten note at the top of the court copy of Berkley’s fax, obtained by TIME, suggests it was forwarded to Carlucci. In 2005, Murdoch stepped down as publisher of the New York Post and appointed Carlucci as his successor, saying he “has a tremendous reputation in the advertising and marketing industries.” The feisty Post has also become enmeshed in News Corp.’s U.K. tabloid scandal as the New York field office of the FBI and the U.S. Attorney for the Southern District of New York, Preet Bharara, look into an uncorroborated report that a British News Corp. tabloid sought to hire a private investigator to obtain the phone records of 9/11 victims and other practices. News Corp.’s lawyers recently told Post employees to retain all documents relating to any potential illegal accessing of personal data “to underscore how seriously we are taking” the U.S. investigation, said editor Col Allan.

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