Already under investigation by the Internal Revenue Service (IRS) for recommending questionable tax shelters, KPMG LLP could now face a lawsuit by WorldCom over what a report called "flawed advice."

U.S. Bankruptcy Judge Arthur Gonzalez ordered the report by former U.S. Attorney General Richard Thornburgh, who delivered what some are calling a roadmap whereby WorldCom could potentially sue KPMG and Citigroup. The report found Citigroup helped former WorldCom Chief Executive Officer Bernard Ebbers to breach his fiduciary responsibility to the company, Bloomberg reported.

Thornburgh’s report raises new issues about KPMG as the auditing firm and WorldCom work together to bring WorldCom, the nation’s second-largest communications firm, out of bankruptcy on schedule next month. KPMG has helped to clear $11 billion in accounting irregularities from the company’s books and WorldCom, now going by MCI, must restate earnings statements from 2000 to 2002 before emerging from bankruptcy.

Thornburgh’s report could pave the way for WorldCom to sue KPMG for malpractice and negligence for helping the company take advantage of what the report called a "highly aggressive" plan to avoid paying hundreds of millions of dollars in state income taxes.

The state-tax strategy "is yet another example of the company converting what could be legitimate into something that appears improper as a result of its aggressive design and implementation," Thornburgh's team said in the 542-page report posted on the website of the U.S. Bankruptcy Court in Manhattan.

"The company is reviewing and considering the potential causes of action against outside parties discussed in the examiner's report," Stasia Kelly, MCI's general counsel, said in a statement.

A KPMG spokesman said the tax strategy is commonly used by other companies, and called the examiner's conclusions "simply wrong," according to the Wall Street Journal.

Update: January 28, 2004

According to a January 28 WSJ report, MCI said that the board will not take action against accounting firm KPMG -- and that the decision eliminates any concerns about independence, even if the company winds up paying back taxes, penalties and interest to the states.

MCI officials say a settlement with state authorities is likely, but that they don't expect the amount involved to be material.