A U.S. bankruptcy court judge on Friday halted payments to WorldCom accountants KPMG after a coalition of states said the consultants had a conflict of interest, according to a source familiar with the matter.
“The judge did not rule on the merits, he simply ordered that payments and disbursements stop pending a further order,” said the source, who asked not to be identified.
KPMG wants $146 million for its work. But the states, in a motion on Wednesday, argued that the accounting firm had devised a tax dodge that let WorldCom shield $24 billion of income from states' taxes.
MCI, formerly known as WorldCom Inc., in 2002 filed the largest bankruptcy in U.S. history, buckling under the weight of $41 billion of debt and an accounting scandal that ballooned to $11 billion.
Nine states have filed claims for back taxes, and in some cases, interest and penalties, ahead of an April 1 deadline, the source said.
They are seeking about $360 million, but that number could grow to about $500 million because another six states plus the District of Columbia also are expected to file, the source added.
KPMG Spokesman George Ledwith reiterated what he told Reuters on Wednesday: “We're confident that KPMG remains 'disinterested' as required for all of the company's professional advisers in its role as WorldCom's external auditor.”
MCI spokesman Bradford Burns dismissed the judge's action on Friday as a “standard procedural step,” adding the tax strategy had been carefully reviewed. “The company concluded that the tax program recommended by KPMG was appropriate.”
Although accountants Arthur Andersen audited the telecom company's books while the accounting scandal was developing, KPMG advised the firm on tax and royalty strategies. And KPMG now is restating MCI's financial reports, a role Judge Arthur Gonzalez of the Southern District of New York has approved.
KPMG counseled WorldCom that its subsidiaries could pay about $24 billion in royalties for management “foresight,” according to Wednesday's filing by the Massachusetts Department of Revenue, which is acting for the states filing claims. This technique enabled WorldCom to shift the income from high-tax states to low-tax states.
The states also asked Gonzalez to approve a different accountant for WorldCom. The telecoms company, which hopes to emerge from bankruptcy in April, wanted KPMG because it already was familiar with its finances.
Massachusetts is shepherding the states' claims against WorldCom, partly because of the expertise it developed hunting companies it says used similar tax-ducking strategies.
WorldCom tops the list of such companies, but Maryland, Missouri, New Jersey, New Mexico and South Carolina all have tried to wring tax dollars out of other corporations that also rely on out-of-state units to shelter income from taxes.
Maryland Comptroller Donald Schaefer, who first began this quest in 1996, is now pursuing 70 companies. And New Mexico has sued Kmart Holdings Corp., charging that the discount retailer avoided $100 million in state taxes around the nation by using an out-of-state holding company.
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