Karzai ordered a panel of self-appointed delegates to investigate reports made by a U.S.-backed panel examining corruption in the ranks of the Afghan government.
A top-ranking U.S. official told The Wall Street Journal that the decision was "a huge blow" to efforts to clean up the Afghan government.
The Journal said the U.S.-backed anti-corruption panel uncovered evidence to suggest an aide to Karzai was linked to bribes at the New Ansari Exchange, an Afghan money-transfer company with strong ties to the Karzai family and members of the Taliban.
Kabul hosted its first donor conference in July to roll out reconciliation and reintegration plans outlined by Karzai during a May visit to Washington. Conference organizers in Kabul bragged that the agenda would give the international community a first-hand account of Afghan efforts at fighting corruption and building a self-reliant military.
Karzai's administration was chastised in 2009 after evidence suggested massive fraud led to his re-election last year.
Embassy officials told the Journal that it was working with Karzai to back up pledges he made during the July conference in Kabul.