WASHINGTON-The auction fraud lawsuit against Wall Street investor Mario Gabelli enters a critical juncture this week, as U.S. District Judge Paul A. Crotty is expected to hear oral argument on the Justice Department’s motion to join litigation accusing Gabelli’s Lynch Interactive Corp. of defrauding the U.S. government of at least $85 million by hiding the firm’s control of winning bidders in wireless auctions-including some that received small-business license discounts and favorable government financing.
The hearing on the Justice Department’s move to become a plaintiff in the False Claims Act suit filed in 2001 by R.C. Taylor III against Lynch Interactive is set for April 26 in federal court in Manhattan.
The Gabelli lawsuit is playing out as the Federal Communications Commission considers reforms to a program offering bidding discounts and other benefits to small businesses and startups known as designated entities in advance of the June 29 start date of one of the most important spectrum auctions in years. Last week, Lynch said it planned to participate in the advanced wireless services auction, which is set to put up for sale 1,122 licenses in the 1710-1755 MHz and 2110-2155 MHz bands.
FCC members said they want to close what they consider is a gaping loophole enabling the nation’s biggest cell-phone carriers and others to essentially front for DEs in spectrum auctions. The FCC is considering barring the four national carriers-Cingular Wireless L.L.C., Verizon Wireless, Sprint Nextel Corp. and T-Mobile USA Inc.-and perhaps other large telecom companies from partnering with DEs.
Some telecom firms now fear the pendulum has swung too far and a tough new proposal tied to FCC Chairman Kevin Martin could backfire by denying small businesses access to funding needed to build capital-intensive wireless networks.
Congress created the DE classification in 1993 to foster more diversity in emerging wireless communications through regulatory incentives available to women, minorities, small businesses and rural telephone companies. The FCC’s DE program was scaled back dramatically after the Supreme Court curtailed federal affirmative-action programs in 1995.
Lynch has steadfastly denied any wrongdoing, saying its relationship to DEs in past auctions was fully disclosed to-and approved by-the FCC.
As such, Gabelli may not be alone in the line of fire. The litigation also could subject the FCC’s auction program to intense scrutiny. Lynch’s attorneys have complained about the FCC’s lack of cooperation in turning over documents. The Justice Department decided it wanted to intervene in the Gabelli case around the time fighting between lawyers for Lynch and FCC attorneys hit fever pitch.
In contrast to allegations that Gabelli profited handsomely from DE licenses won at auction and later sold, Lynch (a Pink Sheet stock) downplayed its spectrum auction business last week in preliminary fourth-quarter results for 2005.
“Over the past 10 years, we have been involved in 19 spectrum auctions conducted by the FCC. Our involvement has been as a venture-capital investor, a service provider, and purchaser of licenses. Many of our efforts have not been successful,” said Lynch. “Over the years, we have had to take write-offs of our investments in spectrum. In fact in 2005 we wrote off our investment in BetaPage Communications L.L.C., who acquired paging licenses in Auction 26. Many of these activities are subject to ongoing False Claims Act litigation.” Lynch’s major holdings include 13 independent telephone companies and two network-affiliated TV stations.
The Justice Department has a slightly different view of the situation. In March filings with the court, Justice asserted that contrary to statements Lynch and others made on FCC applications, the DEs were not small businesses and that none that bid on DE wireless licenses had any written business plan, independent control of finances, or ever offered telecom services. In addition, U.S. government lawyers claim that contrary to FCC rules and regulations regarding de facto control, the DE directors were recruited and organized directly by Gabelli himself. None of the DEs, the Justice Department added, engaged in arms-length negotiations over the terms of the financing offered to them by Gabelli and the Lynch entities.
Justice attorneys also asserted Lynch-affiliated DE bidders did not actually engage in bidding. Justice said one such bidder did not know what spectrum was or what a business could do with a wireless license, and that at least one Lynch entity did not contribute its own equity, but rather used a risk-free loan provided by a business associate of Gabelli.
In its 2003 annual report, Lynch talked about prospects for auctioned wireless licenses-three controlled by minorities-in which it held varying levels of interests. “Operation of these licenses is still in the early stage of development and Lynch Interactive’s ultimate realization depends on how the licenses can be developed and/or liquidated,” Lynch stated. The company said its growth strategy is twofold: successful acquisitions and organic growth.
The Justice Department, which has stood on the sidelines the past five years, said it was obliged to enter the lawsuit after the court ruled Nov. 4 that profits from the sale of wireless licenses by Gabelli and other defendants may only be recovered by the United States, not the original plaintiff, R.C. Taylor III.
Gabelli does not regard the Lynch litigation as a threat to his investment empire, GAMCO Inc. “These developments have no effect on our business operations or our focus on earning a return for our clients,” GAMCO President Doug Jamieson stated previously.
