It is the news story in that has become the talk of dinner parties among America's chattering classes, the scandal rocking one of Manhattan's most prestigious publishing houses.

The pre-Christmas publishing sensation in the United States was a book by James Frey about his criminal lifestyle as an alcoholic and drug addict. It topped The New York Times' non-fiction best-sellers' list for four months, selling 3.5 million copies, thanks in large amount to the support of the world's biggest book club, on the Oprah Winfrey television show, where the work, entitled A Million Little Pieces, was described by the host as "like nothing you've ever read before".

But the blogosphere struck when, earlier this month, The Smoking Gun website ran a piece called "The man who conned Oprah". Initially, the author and his publishers refuted claims that key events in the memoir were not true or that some events and characters presented in the book were copied from two novels by Eddie Little, another drug addict, now dead.

Last week, under mounting pressure, Frey appeared on the Oprah show. He acknowledged that he had embellished many important passages in the book and its sequel, My Friend Leonard, another bestseller (although no admission of plagiarism was made).

Meanwhile, the Forbes website reported overnight that lawyers have filed at least three suits seeking millions of dollars in damages from allegedly defrauded consumers. One attorney is reportedly aiming to assemble a class action on behalf of every Washington resident who read A Million Little Pieces and is demanding that Random House pay consumers for the time they spent reading the book

Yesterday, Random House, who published the first book in hardback and paperback editions under their Doubleday and Anchor imprints, took the unprecedented step of taking out a quarter-page advertisement in USA Today in which they distanced themselves from Frey, effectively conceding that the author had misled them about the book's content. They have offered offended readers a full refund.

"It is not the policy or stance of this company that it doesn't matter whether a book sold as non-fiction is true," the publisher said in the ad. "A non-fiction book should adhere to the facts as the author knows them."

It added: "A publisher's relationship with an author is based to an extent on trust. Mr Frey's repeated representations of the book's accuracy, throughout publication and promotion, assured us that everything in it was true to his recollections ... we have questioned him about the [Smoking Gun] allegations and have sadly come to the realisation that a number of facts have been altered and incidents embellished.

"We ... apologise to the reading public for any unintentional confusion."

According to accounts, Frey had begun work on the book ten years ago, but had his manuscript for a novel rejected by at least 17 publishers, including Doubleday. It was not until he reworked the book and re-presented it as non-fiction that he secured his long sought-after publishing deal.

The Smoking Gun's suspicions were raise after the website, which specialises in publishing embarrassing pictures of celebrities, had trouble tracking down a mugshot of Frey - despite his claimed life as a hellraiser.

Riverhead, publishers of My Friend Leonard, are now reportedly reconsidering a two-book contract they have with Frey. "These are very serious issues and we are treating them that way," a spokeswoman told USA Today.

Frey, who is working on a screenplay about Hell's Angels for the British-born Hollywood director Tony Scott, had maintained that he would sue The Smoking Gun "Let the haters hate, let the doubters doubt, I stand by my book, and my life," he said.

But according to the publishers' statement, he will now have to write an "author's note" that is to be prominently flagged up on all future editions of his controversial book. The publishers, who will also include an explanatory note of their own in future editions, will not sell any further copies of the unamended version.

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