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Can I report it as spam to Google?
Alternately you may want to try filing a DMCA. Be sure to word it well and don't ramble. Be direct. Don't tell any back story. Don't talk about how it's hurting your business. Don't talk about spam. That's all rambling. Just be direct and give the info that the search engines need.
Probably the best way to handle it is to pick up the phone and have a friendly conversation with them. Don't lose your temper. Just be normal. That can work well, fastest, and cheapest.
I would imagine in the end, it depends on the industry you're in. My reasoning as to why it is probably legal in the industry I work in is as follows, using those "novelty gifts" stores as examples:
If a prospective customer types "john's novelty gifts" into Google... they are looking for one of two things:
1. Novelty gifts, wherever they can find them. Perhaps they had heard the name "john's novelty gifts" somewhere, which is why they've searched for it.
2. The actual "John's novelty gifts" store, because they have some interest in that particular store.
in the #1 scenario, they're looking for novelty gifts, not for your company. So if another company can provide novelty gifts, the customer shouldn't be denied that information. In this case, the customer would be perfectly content to see "Sarah's Novelty Gifts" as a search result.
in the #2 scenario, someone who for some reason cannot type your actual url into a browser is using an SE to get to your site. If such a customer sees "Sarah's Novelty Gifts" as a search result, they would not be interested, as that is not what they are looking for. At least, that's the theory.
It's not all that different from someone opening up a store next door to yours that sells the same items... if someone walks down that sidewalk looking for what you sell, you by no means have the right to monopolize the selling of that product on that street... even if it seems totally unscrupulous for a competitor to open up right next door to you. If someone's looking for your store in particular, then they wouldn't give the time of day to the store next door.
The difference with your issue is that piggybacking a competitor's URL is more like them trying to open up a competing store on a street that you OWN.
Specific to Google adwords, it's within their rules to bid on a competitor's name. Many people, I included, like to comparison shop. The name of a competitor is relevant so far as the type of product offered. So one could argue that there is a benefit to the user to be offered an alternative product.
Although if someone is using your business' name or other copyrighted/trademarked phrase in the actual text of their ad, you do have recourse to asking Google to remove the offending ad. But my understanding is that you have to ask.
