WILL MURDOCH BE OUTFOXED?

By ERIK LARSON

It takes a lot to rattle Rupert Murdoch, but in January, as he faced Federal Communications Commission lawyers probing his 10-year-old purchase of TV stations now at the core of his Fox Broadcasting network, he grew clearly angry. "Either your people can't read, don't understand English or understand instruction," he said, his voice stone-hard, "or you have a witch-hunt in this."

It was a telling moment in an investigation that has largely escaped public notice, unfolding in a bureaucratic arena more typically characterized by paper than passion. But nothing about this investigation is ordinary-not the players, not the stakes, not even the FCC's behavior. One of its own commissioners publicly attacked the probe, branding certain actions "misguided." Even the form of the investigation is unusual, with the commission's lawyers demanding documents from throughout Murdoch's U.S. empire and ordering depositions from Murdoch, former Fox Inc. chairman Barry Diller and a dozen other current and former Fox officials.

So far, the investigation has frozen $1 billion in Fox deals to sell and buy TV stations, all meant to help the upstart network catch up with the Big Three. The probe threatens to kill one of these deals, the $38 million takeover of an nbc affiliate in Green Bay, Wisconsin. The FCC's investigation also forced Murdoch to place into trusteeship two powerful stations he bought under an option included as part of his $500 million investment last year in New World Communications, the deal that won Fox a dozen new affiliates-mostly from CBS -- in some of America's biggest TV markets. And the probe halted Fox's aggressive campaign to recruit still more affiliates, giving the Big Three time to shore up their existing relationships. Murdoch, who became a U.S. citizen as part of his bid for entertainment supremacy, is battling the fcc with legal might and free-market indignation. He sniffs, "I thought this was America, where competition was good."

To Murdoch, the investigation is a product of partisan revenge, obsolete law and the machinations of an embittered rival. To others it is a David-vs.-Goliath story in which an obscure Washington attorney (named David, in fact) "took a swing in the dark and hit someone on the chin," as one media lawyer describes it. Still others see the probe as a case study in how companies can abuse the regulatory process. It is nearing its climax just as Congress prepares to jettison a battery of obsolete media regulations and launch an era of explosive competition.

But even instant deregulation couldn't help Murdoch at the moment. What began as a routine proceeding evolved, with a lot of push from Fox-rival NBC into a full-blown investigation of whether Murdoch misled the commission in disclosing how he and his News Corp. would own the original TV stations. If the commission were to rule against him, it could conceivably revoke his licenses, command him to restructure his ownership or mere-ly fine him. Or it could convene a formal hearing, a category of proceeding one media lawyer describes as the "first step toward capital punishment." A full FCC hearing would subject Murdoch to months, perhaps years, of legal wrangling and uncertainty. At a time when speed and confidence are crucial competitive assets, a hearing would hobble Murdoch's ability to strike the kind of stunning deal that has become his trademark. Says Henry Geller, a former FCC counsel, "That would be the end of Murdoch."

Since launching Fox, Murdoch has evolved well beyond his image as an Australian tabloid king given to bashing Britain's royal family. With the Fox studio as his foundation -- his taproot into American TV and film -- he has built an interlocking empire that has made him the widely acknowledged leader in the race to dominate the global media business. Just through his Star TV satellite network, he broadcasts TV programs to 42 million homes in 53 countries throughout Asia. "The light bulb has just gone on that the guy is so integrated, he has so many ways to win, that the networks are by comparison pretty narrow companies," says Steven Lerman, a Washington media lawyer.

Murdoch founded his Fox network a decade ago, when he paid a seemingly exorbitant $1.6 billion to buy six TV stations from John Kluge, head of Metromedia. Mark Fowler, FCC chairman at the time and a fervent apostle of deregulation, remembers joining the pair for their celebratory lunch. "It was hard to see who had the greater Cheshire smile," Fowler recalls. "They were both exceedingly pleased."

The FCC had long cherished the dream of establishing a fourth TV network to give the Big Three some creative and ideological competition. Along came Murdoch, just after buying half of 20th Century Fox, the film studio then headed by Diller. He was hardly an ideal prospect. For one thing, federal law bars companies from owning TV stations and newspapers in the same markets. Murdoch owned the New York Post and hoped as part of the Metromedia deal to acquire WNEW-TV in New York. Moreover, Murdoch was still an Australian citizen, and his News Corp. was organized under Australian law. One of the FCC's primary mandates was to enforce laws restricting foreign ownership of U.S. airwaves. The commission had long interpreted one such law as barring alien companies from indirectly owning or controlling more than 25% of a television station. "Any exception," says Geller, "would have been a blockbuster, a precedent-setting matter."

Murdoch agreed to sell the Post, which he repurchased in 1993 under an FCC waiver granted to help him rescue the struggling paper, but the second obstacle proved more daunting. Murdoch abandoned his Australian citizenship and with great fanfare became an American. Next he structured the deal so that he, now an American citizen, and Diller would together own 76% of the voting control of the stations. Through a long chain of intermediary companies, Murdoch's Australia-based News Corp. would own the remaining 24% of the voting stock, just under the federal threshold.

What the FCC apparently did not know, or had failed to understand, was that this 76-to-24 ratio, while it seemed to satisfy federal requirements, said nothing about who actually owned the underlying assets of the stations. In fact, News Corp. indirectly owns more than 99%, a fact Murdoch's lawyers explicitly disclosed only last year, after prodding by the commission. The question then became: Did Murdoch lie, or was the FCC not competent enough to figure it out?

For years no one openly challenged the deal's structure, although CBS in 1990-91 did try in vain to persuade a senior Congressman and two newspapers to investigate. Virtually anyone can challenge renewals or transfers of broadcast licenses, a practice that acknowledges that the airwaves are public property, at least in theory. Enter David Honig, a Washington lawyer who often represents the interests of minority clients before the FCC. He too had wondered about the deal and, in mid-1993, found the time and a willing client, a unit of the N.A.A.C.P., to allow him to do the necessary digging. The N.A.A.C.P. felt that allowing a foreign company to compete for broadcast properties unfairly impeded the efforts of minority entrepreneurs to do likewise. Late one night, while reading a News Corp. report to the Securities and Exchange Commission, Honig spotted something that intrigued him: News Corp. was claiming Fox as a subsidiary. "But that's funny," Honig recalls thinking. "That's not what Fox was telling the FCC."

Three months later, Honig used Fox's planned purchase of a Philadelphia television station as a forum for arguing that News Corp., a foreign company, illegally owned Fox's stations.

Honig's petition delayed FCC approval of the deal past its "drop dead" date, thus killing the purchase. In frustration, Fox asked the commission to resolve the foreign-ownership question once and for all. How seriously Fox meant this request, however, now seems open to debate. In March the FCC's Mass Media Bureau asked Murdoch to disclose exactly how much equity-what share of the Fox station's assets-was represented by the stock owned by News Corp. In reply, Fox restated the 76-to-24 split but told the FCC that "the precise dollar value of News Corp.'s equity contribution at any given time would appear immaterial." To outsiders, the response seemed an example of Murdoch's legendary arrogance, especially in light of the FCC's insistence on maximum disclosure at all times.

The commission again demanded the information. This time, in a markedly more conciliatory response, Fox disclosed News Corp.'s 99% stake in the stations' assets. Says Honig: "It would be an understatement to say that among communications lawyers, word of that letter was like the bombing of Dresden."

The disclosure was apparently news to two FCC examiners closely involved in the case, Roy Stewart and his assistant Stephen Sewell, both widely respected for their detailed scrutiny of applications. In formal affidavits filed earlier this year, both said they did not know that News Corp. owned so much equity. Murdoch counters that News Corp.'s ownership was fully disclosed in 1985. In his deposition he told investigators he would have been "mad" to hide anything from the commission, given the size of his investment. Of the FCC's Stewart, Murdoch says, "Maybe he just didn't read the application."

Nowhere in the original materials, though, did Murdoch explicitly disclose News Corp.'s 99% share of equity. Moreover, the investigation unearthed documents indicating that foreign ownership remained a sensitive issue among Murdoch's attorneys long after the FCC's initial approval. A memo dated June 5, 1990, from Michael Gardner, a Washington attorney who managed Murdoch's original application, calls Fox's ownership structure "arguably vulnerable to challenge." He warns that it is paramount" to avoid any change that "would potentially invite re-examination" by the commission.

By the end of last summer, rumor had spread among capital media lawyers that the FCC was about to resolve the dispute in a way that would allow Fox to continue operating unimpeded. In the meantime, however, Murdoch, a deal junkie who thrives on unsettling the competition, had launched a revolution in the landscape of television. And he had made an energetic enemy-nbc. "What this is all about is: Murdoch plays by Murdoch's rules," says a former FCC official, "and he just blew NBC's mind."

In the pursuit of "content" to feed his vast global distribution network, Murdoch had gone on a global sports shopping binge, even buying the rights to broadcast badminton to the Chinese. Late in 1993 he outbid CBS for the National Football League's National Football Conference games-a package that also lets Fox broadcast the Super Bowl in January 1997. The deal was vintage Murdoch: The pre-emptive bid outside all bounds of fiduciary caution, based not on the calculations of investment bankers but rather on what Murdoch felt the franchise was worth to him. He knew CBS had the right to top Fox's final bid but believed cbs chairman Laurence Tisch would bring his legendary tightfistedness to the table. "We knew we had to go with a figure that would cut him off psychologically," says Murdoch, relishing the memory.

When Lucie Salhany, then chairman of Fox Broadcasting, announced Murdoch's bid totaling $1.6 billion for the four-year pact, there was a brief silence, recalls Jerry Jones, owner and general manager of the Dallas Cowboys. Members of the N.F.L.'s negotiating team quickly slipped on their best poker faces, but Jones could not restrain himself. He leaped from his chair and cried, "You guys are players!"

The deal showered benefits throughout Murdoch's empire. For Fox's existing affiliates, it proved a bonanza. Many are reporting increases in ratings and advertising revenue. More important, football gave the network new credibility. Fox's Preston Padden, who serves as head of affiliate relations and is Murdoch's point man in Washington, immediately began using the victory to lure affiliates allied with the other networks. He launched his campaign in January 1994 at a national meeting of TV executives, where he operated three presentation rooms to make his pitch, generating contacts that led, he says, to Fox's winning over 50 more full-time and secondary affiliates. Now displayed at Padden's Washington office is a mock wanted poster featuring Padden's grinning face with nbc's logo in the lower left-hand corner. On this poster at least, NBC stands for Nasty Bitchy Crybabies.

Acquiring football, moreover, helped Murdoch achieve his investment in New World, whose cbs affiliates were smarting from the N.F.L. loss. For those stations in particular, says one former Fox executive, "football was the bait."

In the ensuing affiliate scramble, the established networks found themselves forced to boost the amount of money they pay their affiliates for airing network programs. NBC's payout alone increased by a reported $100 million a year. Further insult arrived when NBC learned that a company funded jointly by Fox and Savoy Pictures had made a deal to buy four NBC affiliates and realign them with Fox. Says an attorney for a competing network: "Murdoch pushes and pushes and pushes until somebody says, 'Stop! Enough!"

NBC struck back. Beginning last September, it filed a series of petitions, in which it challenged the pending purchases. It charged in part that the new venture, SF Broadcasting, might violate the fcc's foreign-ownership rules. It was paper warfare, but it did real damage. nbc's challenge may kill the Green Bay deal, which has a drop-dead date of April 28, and it has stalled fcc approval of SF Broadcasting's $229 million agreement to buy the other three NBC affiliates.

But NBC widened its attack still further. In November it sought to block Fox's effort to buy TV stations in Philadelphia, Boston and Denver, arguing that the FCC could not approve these purchases until it had resolved the SF dispute. Next, citing the 99% ownership disclosure in David Honig's N.A.A.C.P. case, nbc filed a formal request that the commission clarify its rules on foreign control, thereby boosting pressure on the commission to examine Murdoch's ownership. "What are you doing this for?" Murdoch demanded in a telephone call to Robert Wright, president of NBC. "The record is clear. You can't be serious." Wright replied: "You've cost me a lot of money. I've got to stop you."

Murdoch wrote directly to FCC chairman Reed Hundt, declaring his "personal anguish" at the whole affair. But he backed his tears with bullets. That same day his Washington attorney, William Reyner Jr., also wrote to Hundt, at one point accusing NBC parent General Electric of having engaged "in a pattern of illegal activity, including criminal fraud, antitrust and anticompetitive conduct." He listed a series of examples, including GE's 1992 guilty plea on four counts of fraud associated with a sale of aircraft engines to Israel. These sins, Reyner continued, called into question "NBC's basic qualifications to continue as a licensee of broadcast stations."

But just as the feud threatened to get really ugly, NBC withdrew its challenge. The battle had got "much too personal," Wright said. It became clear, however, that something more than conscience had come to bear: nbc announced that it had reached an agreement with Murdoch under which nbc would be able to transmit some of its cable programming over Murdoch's Star TV network.

NBC's withdrawal did nothing to end the investigation. A hearing remains a possibility, but several influential Washington media lawyers say they expect the commission to take a middle-ground stance: ordering Murdoch to restructure his ownership of the Fox stations, a decision that might subject him to a huge Internal Revenue Service bill but would leave his network otherwise intact. The investigation may already have done much more serious harm, allowing Fox's competitors to negotiate 10-year deals with their affiliates and thus delay Fox in its race to overtake one or more of the established networks.

Right now, however, the clearest loser may be the FCC itself. Any decision-from blanket exoneration to convening a hearing-is likely to draw fire. In its zeal to restrain public comment on the case, the commission in December issued a sweeping gag order-so extensive that it had the perverse effect of stirring more attention and igniting criticism of the FCC's self-conscious handling of the case. In a scathing critique, James Quello, a veteran commissioner, even noted that the fcc's general counsel told commission staffers they could go to an nbc Christmas party but not to a Fox party. That decision, Quello wrote, "added to questions about the overall impartiality of our procedures."

None of which is lost on Murdoch. A vague smile plays across his face. Sitting back on a couch in his New York office beside a wall of silently flickering TV screens, Murdoch says, "I take some comfort in that I would imagine the fcc themselves have got to come up for all sorts of scrutiny from this new Congress." He argues that it doesn't matter in the end how much equity News Corp. owns because he is an American and indisputably controls News Corp. So, he reasons, even the contested 24% share of the Fox stations is ultimately under American control. During a rare press conference in late February, he barked: "I'm an American. You may not like it, but you better get used to it."