Federal prosecutors negotiating a possible settlement with KPMG LLP regarding its sale of allegedly abusive tax shelters are reportedly considering imposing government supervision and new restrictions on the Big Four auditor’s tax practice.

To avoid a criminal indictment, KPMG would also have to pay about $450 million in penalties, according to The Wall Street Journal, citing people familiar with the matter.

Reportedly, the Department of Justice has tentatively selected former Securities and Exchange Commission chairman Richard Breeden as an outside monitor for KPMG. Breeden, a former executive of accounting firm Coopers & Lybrand, was also the court-appointed monitor for WorldCom Inc. and the lead investigator for Hollinger International’s internal probe into financial misdeeds at the newspaper chain. The Journal also noted that WorldCom (now MCI Inc.) and Hollinger are KPMG audit clients and had been KPMG tax-shelter clients.

In related news, federal prosecutors in New York are expected to file indictments that charge several former KPMG partners with fraud and conspiracy, the newspaper reported. Regardless of whether KPMG faces federal charges of its own, the Journal added, the firm will still have to contend with potentially costly class-action lawsuits regarding the tax shelters.

Earlier this week, Bloomberg reported that the other major accounting firms — Deloitte & Touche, Ernst & Young, and PricewaterhouseCoopers — have ordered their partners not to poach clients from KPMG during its negotiations with the government. The hands-off policy was reportedly intended to help KPMG avoid the fate of Arthur Andersen, which was accused by federal prosecutors of obstructing an investigation into audit client Enron Corp. The firm’s conviction reduced the number of large accounting firms to four, leaving its rivals to pick up many of Andersen’s auditing clients and partners.

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