A 30-year-old law limiting the liability of auditing firms has come under renewed scrutiny amid concerns it fosters negligence and shields firms from full accountability. The Professional Standards legislation, enacted by the Commonwealth to cap damages for accounting firms, restricts their financial responsibility for audit failures to a modest multiple of their fees, regardless of the extent of any damage caused.

This legal framework has been criticized for creating a moral hazard, insulating audit partnerships from the severe financial consequences of their misconduct. While incorporated companies can be held liable up to the value of their assets, audit partnerships remain personally liable only to the extent of their capital contributions, never risking bankruptcy due to negligence. Critics argue this arrangement encourages reckless behavior by reducing firms’ incentive to maintain high standards.

In 2021, former Treasurer Josh Frydenberg intervened to require that claims against companies concerning continuous disclosure breaches demonstrate “knowledge, recklessness or negligence,” replacing the previous strict “no-fault” liability regime. This change sought to balance accountability for misconduct with the need to keep directors insurable, avoiding what is colloquially known as being left “naked”—uninsurable due to unchecked personal liability exposure.

Former KPMG partner and whistleblower Brendan Lyon has highlighted how this legislative shield enables misconduct, stating that auditing firms act recklessly “because they could” under the current liability regime. Lyon has since initiated legal proceedings in the New South Wales Supreme Court aimed at restricting the liability cap to audit services alone, arguing against its expansion into consulting and other accounting services.

The liability cap’s extension beyond auditing has raised concerns about unfair competition, as incorporated consulting firms face full liability while large accounting firms benefit from diminished financial risk. This disparity, critics say, has allowed professional service firms like KPMG and PwC to act with increasing arrogance, even as public scandals have emerged.

Internal emails from KPMG’s leadership in 2023 illustrate the tension within the profession. At the time, then CEO Andrew Yates and Chairwoman Alison Kitchen urged staff to uphold ethical behavior in the wake of PwC’s misconduct revelations, condemning the actions as detrimental to the profession’s reputation. Yates has since resigned publicly, while Kitchen remains on the boards of National Australia Bank and Worley, continuing in senior audit roles.

Calls to abolish the liability cap altogether rest on the principle that firms seeking limited liability protections should operate as companies rather than partnerships. Advocates suggest government support should facilitate the transition of audit partnerships into limited liability companies, extending restructuring relief offered to other business entities such as trusts.

Until legislative reforms address the perceived moral hazard and financial protections granted to audit firms, attempts by policymakers to enhance accountability may fall short of substantive change. The dispute underscores ongoing tensions between maintaining robust corporate oversight and preserving the viability of key professional service providers within Australia’s financial system.