States Fail to Persuade Judge to Disqualify KPMG as MCI Auditor

A federal bankruptcy judge on Wednesday ruled that KPMG LLP’s sale of a state-tax shelter to MCI did not create a conflict of interest, the Wall Street Journal reported.

Therefore, the firm should be allowed to continue providing tax and audit services to the telecommunications company, the judge ruled.

The lawsuit to disqualify KPMG was brought by 14 states that are seeking more than $500 million in back taxes from MCI, known as WorldCom Inc. when it filed for bankruptcy protection two years ago. The states claim the tax shelter was a scam, but U.S. Bankruptcy Judge Arthur Gonzalez was unimpressed by the way in which the states pursued their legal action.

In a 37-page opinion, Gonzalez wrote that the states waited too long to file their request, blasting it as "a litigation tactic" that they used to strengthen their positions in settlement talks with MCI over the tax claims.

The states "have had access to the information necessary to raise the issues that are the subject of the disqualification motion for more than 10 months," Gonzalez wrote. "It was only after the states decided that such a motion would advance their particular interests that they filed the disqualification motion."

The states said in court papers that KPMG audited its own work as a result of the tax shelter, which involved valuing the "foresight of top management" as an asset worth billions of dollars in the late 1990s. WorldCom then charged its various units royalty fees to license this asset. The subsidiaries then deducted these fees, which were accrued on paper but not paid in cash, as business expenses on their state-tax returns.

George Ledwith, a KPMG spokesman, said, "KPMG finds it noteworthy that Judge Gonzalez held that KPMG has no interest adverse to the MCI bankruptcy estate, that the provision of audit and tax services to MCI is legally permitted and that these relationships did not present any appearance of impropriety."

The ruling allows KPMG to resume collecting fees from MCI. In March, Gonzalez barred MCI from paying KPMG, pending his decision on the states' motion. At that time, KPMG had either received or charged MCI more than $146 million.

The Securities and Exchange Commission is conducting its own inquiry into KPMG's auditor independence stemming from the same issues.