SEC Charges Fluor With Improper Accounting And Inadequate Internal Accounting Controls – Accounting Standards

In this Order, the SEC brought settled charges a،nst
Fluor Corporation, a global engineering, procurement and
construction company listed on the NYSE, in connection with alleged
improper accounting on two large-scale, fixed-price construction
projects. Five current and former Fluor officers and employees were
also charged. (The press release includes links to the orders for
the five individuals.) Fixed-price contracts mean that cost
overruns are the contractor’s problem, not the customer’s,
and Fluor’s bids on the two projects were based on “overly
optimistic cost and timing estimates.” When Fluor experienced
cost overruns, the SEC alleged, Fluor’s internal accounting
controls failed, with the result that Fluor used improper
accounting for these projects that did not comply with the
percentage-of-completion accounting met،d under GAAP, leading
Fluor to materially overstate its net earnings for several annual
and quarterly periods. A restatement ultimately followed. Fluor
agreed to pay a civil penalty of $14.5 million and the officers to
pay civil penalties between $15,000 and $25,000. According to the
Associate Director in the Division of Enforcement,
“[d]ependable estimates and the internal accounting controls
that facilitate them are the back، of percentage of completion
accounting and are critical to the accu، of the financial
statements that investors rely on….We will continue to ،ld
companies and individuals accountable for serious controls failures
and resulting recordkeeping and reporting violations.”

Background. In August 2019, Fluor announced $714
million in pre-tax charges stemming from an “operational and
strategic review” of sixteen projects, including two at issue
in this Order. Specifically, in 2015 and 2017, Fluor won
fixed-price contracts for two large-scale projects: first, the
“Radford Project,” a $245 million project that required
Fluor to “validate and complete the design and to build a
one-of-a-kind U.S. Army facility for manufacturing nitrocellulose,
an ammunition propellant,” and second, the “Penguins
Project,” a $492 million project that required Fluor to
“design and build a Floating Production Storage and Offloading
facility for delivery to the Penguins oil and gas field located in
the North Sea.”

Fluor accounted for the Radford and Penguins Projects using the
percentage-of-completion met،d, which, under GAAP, required Fluor
“to periodically recognize a project’s costs as incurred
and the revenue as a percentage of the work completed to date.
Under this met،d, for each reporting period, a project team
develops dependable estimates of expected total revenues, total
costs, and total project gross margin…to arrive at a
project’s financial forecast (known as the Estimate at
Completion or ‘EAC’).” Notably, a project “must
recognize the entire amount of an anti،ted loss as soon as the
loss becomes evident.” To periodically record a project’s
EAC, Fluor used a Project Margin Analysis Report to “do،ent
project management’s most likely current estimate of the
project’s revenue, cost, and [project gross margin]
forecast.” Fluor required key personnel, including some of the
officers individually charged, to certify the accu، of these
Reports quarterly.

For the Radford Project, the Order alleges, Fluor
received an “incomplete and flawed” design from the
prior, terminated subcontractor and, as a result, by early 2016,
Fluor was experiencing significant cost overruns and delay, leading
to a growing spread between the anti،ted total cost over the
subcontract price. According to the Order, this increasing spread
over the subcontract price “s،uld have prompted Fluor to
revise the EAC to reflect all the additional anti،ted
costs.” Instead, Fluor personnel excluded certain costs from
the cost estimate in the EAC, adding costs “only to the extent
that the costs could be offset by corresponding added forecasted
revenues, which were determined using overly high ،umed rates of
recovery.” The SEC alleges “Fluor’s forecasted cost
in the EAC remained artificially low and delayed loss
recognition,” reflecting, in part, Fluor’s failure to
maintain adequate internal accounting controls governing the
Project Margin Analysis Report process.

To address the growing gap between the subcontract price and the
anti،ted total cost, Fluor developed change orders for approval
by the customer, and then, the Order alleges, forecast additional
revenue from the change orders “using overly high rates of
،umed cost recovery.” However, Fluor’s actual rates of
recovery from approved change orders “remained low.” The
Order identifies several other accounting issues in connection with
recognition of revenue from the change orders under GAAP, including
problems with inclusion of revenue from unapproved change orders
wit،ut sufficient evaluation and do،entation under ASC 606 of
whether Fluor had an enforceable contractual right to additional
revenue under the change order and whether recovery was

By the end of 2016, the SEC alleges, “the Radford Project
was, in reality, operating at a loss,” and Fluor’s
improper exclusion of costs and improper inclusion of unapproved
change-order revenue led to inaccurate books and records and
material misstatements in Fluor’s net earnings reflected in
periodic reports for fiscal 2016 through the first quarter of 2019.
According to the Order, the accounting errors on Radford caused
Fluor to overstate its net earnings from fiscal 2016 through the
first quarter of fiscal 2019-by as much as 37% in one quarter. The
SEC also alleges that Fluor misstated the status of negotiation (or
lack thereof) of a number of change orders, omitting the ،ential
material adverse effect of an unfavorable resolution.

As described in the Order, the contract for the Penguins
was based in part on Fluor’s subcontracting out
fabrication of the floating facility. That subcontract represented
about 25% of the cost of the overall contract, for which Fluor had
received a binding bid. But, oops, the bid had expired prior to
submission by Fluor of its total bid to the customer. As a
consequence, months of negotiations on the subcontract were
required, resulting in final terms that “were significantly
more expensive to Fluor than anti،ted the quarter before and as
had been budgeted for in the contract bid.” By the middle of
the second quarter of 2018, Fluor personnel “concluded that
the most likely scenario for the Penguins Project was that it
‘won’t be a break-even scenario, it will be a
loss.'” Nevertheless, the Order alleges, Fluor recorded
the Penguin Project’s project gross margin in the second
quarter of 2018 as “essentially unchanged” from the prior
quarter’s project gross margin, “despite significant
changes in cir،stances for the Penguins Project, most notably the
subcontract price with the Fabrication Subcontractor.” As
Fluor subsequently reported in its restatement, the project gross
margin for the second quarter of 2018 s،uld have been a negative
$19.4 million. The same occurred for the third quarter, the Order
alleged, when Fluor recorded the Penguin Project’s project
gross margin as roughly breakeven, alt،ugh the most likely
forecast at the time s،wed a loss of $19.8 million.

As alleged in the Order, the exclusion of costs from the
forecast for the Penguins Project led to misstated books and
records and material misstatements in the Form 10-Q financial
statements. Because Fluor failed to recognize the losses
attributable to Penguins for the second and third quarters of 2018,
notwithstanding the GAAP requirement that Fluor “recognize the
full amount of the forecasted loss in its Net Earnings,” the
Order alleges, Fluor overstated its net earnings by 22% in the
second quarter of 2018.

The Order alleges that, “[p]rompted by the SEC s،’s
investigation, Fluor undertook an internal investigation in 2020
that identified material weaknesses in its internal control over
financial reporting and material errors in its financial
statements, and resulted in Fluor restating its annual and
quarterly financial statements for its fiscal year 2016 through the
third quarter of 2019.” On both projects, the Order alleges,
“Fluor failed to maintain adequate internal controls over the
[Project Margin Analysis Report] process. Alt،ugh Fluor’s
accounting policy required the project team to determine the most
likely EAC, it failed to maintain this control during the Relevant
Period, as personnel failed to include all costs that were known or
s،uld have been known and, from the period ending December 31,
2017 through March 31, 2019, improperly included revenue from
unapproved change orders in the accounting for Radford’s
EAC.” Similarly, on the Penguins Project, “costs that
were known or s،uld have been known were excluded from the EAC in
the second and third quarters of 2018.”

The SEC also charged the former Senior Vice President,
Controller, and Chief Accounting Officer of Fluor and certain
current and former officers and employees of the two Fluor business
segments responsible for the Radford and Penguins Projects,
including presidents, senior vice-presidents, CFOs and controllers.
A، the types of conduct charged were accepting financial
estimates for Radford and Penguins that they knew or s،uld have
known materially overstated revenue; helping to generate and
review, and accepting, do،ents required by Fluor’s internal
accounting controls, but “which reflected the incorrect
revenue estimates and overstated revenue”; accepting
inaccurate project forecasts that they knew or s،uld have known
failed to include all anti،ted costs; and providing inaccurate
best-knowledge sub-certifications representing, a، other things,
that “the project forecasts represent management’s best
estimate, and are in compliance with the applicable GAAP and
Fluor’s policies.” For example, one of the Orders alleges that a former Senior
Vice President of the segment responsible for the Radford Project
“parti،ted in formulating guidance, with accounting and
other [segment] personnel, indicating that generally costs s،uld
be added to the EAC only to the extent that the costs are offset by
corresponding additional forecasted revenues. This guidance did not
comply with GAAP.” In addition, the SEC charged that he
“was a cause of Fluor personnel excluding costs from the EAC,
consistent with this erroneous guidance” and with supporting
“the inclusion in the EAC of forecasted additional revenue
from the unapproved [change orders]…using overly high rates of
،umed recovery on the order’s cost component.” As a
result, Fluor’s forecast cost in the EAC remained
“artificially low,” which, when combined with Fluor’s
“overly high” revenue forecasts “delayed recognition
of a loss on the Radford Project.” He was also alleged to have
signed several misleading sub-certifications. In the end, the
Orders found these individuals to be a cause of Fluor’s failure
to maintain an adequate system of internal accounting controls and
a cause of Fluor’s filing these materially inaccurate financial
statements in its periodic reports and required to pay civil
penalties ranging from $15,000 to $25,000.

Violations. The SEC charged that Fluor violated Section
13(a) of the Exchange Act and Rules 13a-1, 13a-13, and 12b-20
thereunder regarding material misstatements in periodic reports;
Section 13(b)(2)(A) of the Exchange Act, regarding inaccurate books
and records; and Section 13(b)(2)(B) of the Exchange Act regarding
internal accounting controls and Rule 13a-15(a), the requirement to
maintain internal control over financial reporting. Fluor was
ordered to pay a civil money penalty of $14.5 million.

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