A shipbuilder for the US Navy got itself into some deep…ship…over fudged profits on major projects—you might say all hull broke loose—and its failures have some lessons for finance executives beyond the obvious advice not to do fraud.
Austal USA, a subsidiary of Australian company Austal Limited, pleaded guilty on Aug. 27 to resolve a Justice Department investigation related to accounting fraud and obstructing the Defense Contract Audit Agency (DCAA) during an audit, and agreed to pay a criminal fine and restitution of up to $48 million to the Securities and Exchange Commission (SEC) that the commission will use to pay out investors harmed by the company’s misconduct.
The government alleged that Austal and co-conspirators worked from roughly 2013 to mid-2016 to fraudulently reduce the estimated costs of building ships by tens of millions of dollars, which “illegally inflate” Austal USA’s profits on ships it was building for the Navy, Nicole M. Argentieri, head of the Justice Department’s Criminal Division, said in a press release.
Austal’s founder and director, John Rothwell, said the settlement was the best outcome, according to AFR Magazine. “Upon learning of this issue, Austal conducted its own independent investigation and we have made numerous governance changes to prevent similar issues from occurring again.”
How they did it. Austal USA overstated the profitability of its shipbuilding by lowering the estimate at completion (EAC) for ships it was constructing, according to the Justice Department. The phony accounting let its parent company recognize revenue from the projects that helped it hit or even beat analyst forecasts for earnings before interest and tax (EBIT), according to the SEC’s charges. Those fake profits helped increase Austal Limited’s share price—for a time. When the investigation revealed the fraud, the parent company “wrote down over $100 million” and the stock price tanked, the DOJ said.
Austal “is really a textbook example” of a company exploiting its discretion over expected future cash flows to dupe investors, NYU accounting professor Eli Bartov told CFO Brew. A company underreporting expenses to inflate income “is not unusual,” he said, although in general, “it’s difficult for me to tell you how pervasive fraud is, because most of it has gone undetected.” The SEC is too short-staffed and “lacks the expertise” to catch fraud much of the time, he said.
Jordan Rippy, an accounting professor at Johns Hopkins University, said most financial fraud isn’t complicated. In an email to CFO Brew, she told us Austal’s case is not an exception. “They basically said that it was costing much less to build the boat than it was supposed to cost. On the face, that doesn’t make much sense given what we know about inflation over the past few years in the post-Covid economy.”
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Consequences? As part of its guilty plea, Austal USA will “serve three years of probation,” according to DOJ, keep implementing a compliance and ethics program, and hire an independent compliance monitor for three years. Former Austal USA executives are personally on the hook, as well: Its former president and two other top executives for financial analysis and a combat shipbuilding program were indicted in 2023 and face upcoming trials.
As of now, the company will still get to build ships for the Navy. The guilty plea “does not automatically result in its exclusion from federal contracting,” Navy spokesperson Commander Tim Hawkins told CFO Brew in an email. While the Navy took part in the investigations “to hold Austal accountable,” he said, “[t]he Navy was not directly harmed by Austal’s actions—neither monetarily nor by any failure to meet contractual obligations to the government.”
Shares of Austal Limited initially rose more than 4% on the news, “a sign the market thinks it can navigate a way forward with the US government,” according to AFR. It reported that Austal is trying to negotiate with the Navy to “maintain its standing as a responsible contractor” so it can keep doing work for the US government. The agreement “would set out compliance commitments, access, [and] reporting obligations, and introduce an independent monitor.” Other large defense contractors have kept the government’s business after getting busted by regulators, AFR reported.
It ends with us. It’s not just a book-to-movie adaptation with mixed reviews. If they’re in the unenviable position of encountering something that gives off fraudulent vibes, finance leaders should use their gut and their head.
“My best advice is trust yourself when you see things that don’t make sense, and then go investigate them until you’re satisfied that you understand what’s happening,” Rippy said. “Ask lots of questions. And make sure you really, truly understand where the money is coming from and where it’s going.”
“The most obvious red flag to consider is when something just doesn’t seem to track,” she continued. “One of my favorite frauds to talk about is the Collin Street Bakery fraud in Texas. It did not make sense that someone making the salary of a comptroller of a bakery shifted to living the kind of expensive and extravagant lifestyle he was living.”
Executives can also create an environment that doesn’t encourage fraud. If fraud has occurred at a company—and it wasn’t the CEO and CFO behaving badly—it’s probably because the leaders at the top “inspire[d] their employees to do that,” Bartov said. “Remember, it’s the tone at the top that dictates the culture in the company.”