Washington (Jan. 29, 2004) -- The company formerly known as WorldCom could sue Big Four firm KPMG for bad tax advice, Smith Barney for breach of fiduciary duty, and defunct accounting firm Arthur Andersen for negligent auditing, according to a report released this week.

The company, which is in bankruptcy court, could also sue its former chief executive, Bernard Ebbers, for breaches of fiduciary duties, as well as its remaining former directors, according to the 542-page report issued Jan. 26 by bankruptcy court examiner and former U.S. attorney general Richard Thornburgh. At the same time, the company, which is in bankruptcy court, could be owed hundreds of millions of dollars in state claims for back taxes, the report said.

WorldCom, which changed its trade name to MCI, reported massive accounting irregularities in 2002 that led to mammoth financial restatements. It reached a settlement with federal securities regulators last July. Last fall, former CEO Ebbers pleaded not guilty to securities fraud and other charges.

The report noted that WorldCom's aggressive tax minimization program, based on advice from KPMG, “is seriously vulnerable to state challenge,” with several states already seeking back taxes. If the states are successful in their claims, the company could also owe interest and penalties that the report said could amount to "hundreds of millions of dollars." WorldCom could allege that KPMG was "negligent" in proposing the programs in question, according to the report.

"KPMG may be able to defend against some, but likely not all, of any such company claims on the basis that the company failed to follow" some of its tax advice, the report said.

Thornburgh also said that Salomon Brothers, later Salomon Smith Barney, a Citigroup subsidiary, won WorldCom's investment banking business because it repeatedly provided Ebbers with "enormous allocations of IPO and secondary offering shares" on which Ebbers had gross profits of more than $12 million, giving the firm cause to sue both Salomon and Ebbers for breach of fiduciary duties. In addition, the examiner concluded that Arthur Andersen "committed professional malpractice" by negligently failing to carry out "the kinds of substantive tests that were warranted by the risks of fraud and material misstatement" Andersen identified, as well as the existence of red flags relating to WorldCom's accounting practices.

"Our corporate tax work for WorldCom was performed appropriately, in accordance with professional standards and all rules and regulations, and we firmly stand behind it," KPMG said in a response to the report. "The examiner's conclusions are simply wrong."

While noting that the company is "reviewing and considering the potential causes of action against outside parties discussed in the examiner's report," MCI executive vice president and general counsel Stasia Kelly said in a statement that the company has no plans to sue KPMG.

"KPMG's involvement in this program has previously been carefully reviewed by our current audit committee of the company's board of directors and the company's inside and outside tax counsel," Kelly said. "Based upon this earlier review, the company concluded that the tax program recommended by KPMG in 1997 and 1998 was appropriate. As a result, the company has no plans to pursue claims against KPMG."

Kelly's statement noted that the firm is "thoroughly reviewing" Thornburgh's final report and is inviting him to present his findings to its board of directors as part of "ongoing efforts to ensure that what happened in the past will never happen again."

KPMG added, "The tax strategy employed by WorldCom and still in effect today is commonly used by companies with subsidiaries in many jurisdictions to simplify their state tax structure."

"The real issue at hand is whether the branding strategy satisfies the test of an intangible asset. We certainly believe that it does," the firm said, noting that it provided the examiner with information during his investigation, but wasn't given the chance to review his findings before the report was published.

-- WebCPA staff

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