Yes ita big deal to get his Naturalization papers intact.
it should be verified before giving LPR status of His dependents.
thate can be any thing. is therre any name change, or any other official changes ahappend which was never informed to INS/USCIS.
How he got naturalized. etc. record has to be chacked.
ANswer to your questions.
1. if sponsor had aquired his status with fraud or mis rep , then YES AOS will be denied. To make sure He has to correct his record first. Once it is clear he has real naturalization then status only be denied if any reason other offence of immgrationlaw OR others.
2. YES if record not found then case will be on hold. or can be denied, or it can be declared that his citizenship is not real.
( BIG PROBLEM)
3. not related if INS/USCIS treat the foul play.
YEs there is many way to get this straighten out.
Give the evidence that How he was naturalized, His Alien Number. Copy of any record filed with INS. Where filed. INitiate the *****y for Main Record center( will take time ) . get supervisor involved in the case, as well as Local congress man.
Your attorney should be talking to superiors in USCIS. If talking to Supervisor get the record then file the complaint against USCIS officer.
Its a discussion, not a legal advise..