Britain's News of World tabloid hired a private investigator to carry out surveillance on two lawyers who represented phone-hacking victims, reports said.
Former police officer Derek Webb secretly filmed Mark Lewis, the lawyer who represented the family of Milly Dowler, a murdered teenage girl whose phone was hacked by the now-defunct paper, the Guardian newspaper and the BBC reported.
The surveillance was an attempt by the tabloid to show that Lewis was having a relationship with lawyer Charlotte Harris, who also represented hacking victims, and was sharing confidential information, said the BBC.
Webb also reportedly spied on Harris, Lewis's former assistant.
News International, Murdoch's British paper wing that published the tabloid, admitted that the lawyers appeared to have been subject to "deeply inappropriate" surveillance but sought to distance current executives from the scandal.
"News International's enquiries have led the company to believe that Mark Lewis and Charlotte Harris were subject to surveillance," a company spokesman said in a statement.
"While surveillance is not illegal, it was clearly deeply inappropriate in these circumstances. This action was not condoned by any current executive at the company."
The Guardian said the surveillance was carried out during the past 18 months when James Murdoch, the Australian-born media mogul's son and heir apparent, was News International chairman.
The allegation heaps pressure on the younger Murdoch ahead of an appearance before British lawmakers on Thursday when he will be grilled over the phone-hacking scandal for a second time at a parliamentary committee hearing.
Labour lawmaker Tom Watson, who sits on the Commons' culture select committee, said Murdoch had some "very serious questions to answer."
"His original testimony has not just been contradicted by the former editor of the News of the World but it's been contradicted by Tom Crone, the in-house lawyer," he told the BBC.
He said the latest twist revealed "an utterly relentless and ruthless organization, clearly highly politicized and who would stop at nothing to try and cover this case up."
The closure of News of the World in July has sent shock waves through Murdoch's News Corp. media empire.
Webb, who ran a private investigation firm called Silent Shadow, told the BBC he was commissioned by the tabloid to carry out surveillance on Lewis and Harris in early 2010.
He said he was paid to go to Manchester, where the lawyers were based, and once followed Lewis's former wife and his daughter, filming them when they visited shops and a garden centre.
According to the Guardian, the News of the World also took advice to see if it could injunct Lewis and prevent him from representing alleged hacking victims, and tried to persuade one of his former clients to sue him.
Lewis has been the most prominent lawyer representing alleged hacking victims.
As well as the family of Dowler, whose case escalated the crisis at the News of the World and led to its closure, Lewis also represented the chairman of the Professional Footballers' Association Gordon Taylor, who won a huge payout from the paper.
Harris represented leading public relations agent Max Clifford.