Securities Regulation Daily Mixed results for bond buyers in VW emissions case
Thursday, July 20, 2017

Mixed results for bond buyers in VW emissions case

By Mark S. Nelson, J.D.

A federal judge in California found a complaint adequately alleged that statements contained in a bond offering memorandum issued by Volkswagen AG were misleading and that bond purchasers also alleged scienter regarding the company’s CEO and the company itself. But the court also said the plaintiff could not pursue claims outside the offering memorandum and that the complaint was deficient regarding the scienter of a VW AG subsidiary and that entity’s CEO. Allegations regarding financial statements attached to the offering memorandum were similarly deficient. The court also found that VW AG’s CEO was subject to specific jurisdiction (In re: Volkswagen "Clean Diesel" Marketing, Sales Practices, And Products Liability Litigation, July 19, 2017, Breyer, C.).

The bondholder’s case is one of several pending against VW arising from revelations about the company’s efforts to evade U.S. and state vehicle emissions standards. Holders of VW’s American Depositary Receipts also sued the company as did federal and state regulators (the company also pleaded guilty to several felonies). The bondholders alleged that Volkswagen misled them about the company’s efforts to reduce vehicle emissions in an offering memorandum (and attached financials) for bonds sold in 2014 and 2015 for $8.3 billion to qualified institutional buyers via private placements.

Standing and misleading statements. The court swiftly dealt with the defendant’s assertion that the bond plaintiffs lacked standing. The court said lead plaintiff Puerto Rico Government Employees and Judiciary Retirement Systems Administration could state its own claim and that the "class certification approach" undercut VW’s arguments about other putative class members. The court then focused its discussion on whether statements in a bond offering memorandum were misleading and whether any of the individual or corporate defendants made those statements with scienter.

Although the court said various statements in the body of the offering memorandum were not "necessarily false," they could be, as the lead plaintiff argued, "generally misleading" because they gave rise to an inference that the bonds were a worthwhile investment in light of Volkswagen’s commitment to cutting vehicle emissions. After all, there was no dispute among the parties that information about the defeat device was material.

Likewise, the court rejected the defendant’s argument that the risk factors section of the offering memorandum could not result in liability. Cases examined by the court had addressed the question "in isolation" without reference to context. In the VW case, statements about the company’s research and development efforts provided the needed context by which a fact finder could conclude the body of offering memorandum was materially misleading.

Moreover, statements about the "top priority" and the "focal point" of VW’s R&D for vehicle emissions were not mere puffery, as the defendants had argued, because they were specific in nature as compared to cases cited by the defendants where the statements at issue were vague. As a result, the court concluded that a fact finder could determine the statements were misleading in context and with reference to other information about the defeat device.

Mixed results regarding scienter. The individual defendants, the CEOs of VW AG and VWGoA, argued that they could not have acted with scienter because they did not make the statements in the offering memorandum because neither had signed the offering memorandum (one of them had signed the attached financials but that signature dealt with historical statements that predated the offering memorandum). Still, the court concluded, partly based on a similar finding in the ADR case against VW, that the two CEOs had "ultimate authority" regarding the offering memorandum so they could be makers in the context of the Supreme Court’s Janus opinion.

Allegations of scienter regarding the CEO of VW AG were sufficient to support a strong inference of deliberate recklessness. The court reasoned that the executive’s "attention to detail," his selection of top aides who were key figures in the company’s probe of the defeat device, and the critical role of "clean diesel" to U.S. sales favored a finding that the complaint adequately pleaded scienter.

As for the CEO of VWGoA, the compliant failed to plead scienter. The plaintiffs alleged that the CEO received an email about the defeat device on the day VW issued the offering memorandum. But the court said it would have been reasonable for the CEO to take up to a week to investigate the email (the ADR case reached a different conclusion, but that case had also emphasized the email and additional allegations). Moreover, the court rejected application of the core operations theory of scienter because the CEO did not have access to a store of information (e.g. a database) regarding the defeat device.

Moreover, VW AG’s CEO’s scienter could be imputed to VW AG, but the complaint failed to allege scienter regarding VWGoA. In the latter instance, the individual CEO of VWGoA lacked scienter and the court declined to apply the collective scienter theory because the statements in the offering memorandum were misleading, not false.

The court also concluded that historical financial statements appended to the offering memorandum could not support a Section 10(b) claim. International Accounting Standards only required the provision for probable liabilities noted by the plaintiff’s complaint once the loss was probable. The court further explained that the relevant events related to the offering memorandum occurred after the lead plaintiff’s bond purchase was final.

Reliance. The VW defendants had challenged the alleged basis for reliance in the case, arguing that neither of the rebuttable presumptions created by the Supreme Court in Basic and Affiliated Ute applied. The court concluded that Affiliated Ute did apply, despite the mixed nature of the case, because the complaint primarily alleged omissions and only included alleged misrepresentations to show the misleading character of the omissions.

Controlling persons. The court rejected allegations that VWGoA’s CEO was a controlling person because the underlying primary securities allegations against him were to be dismissed. But VW AG’s CEO could be a controlling person of VWGoA because he was CEO of the parent company of the entities involved in the defeat device scandal, because of the prominence of clean diesel to VW’s U.S. segment, and because of the CEO’s reputation as a micromanager, although allegations about his day-to-day activities by themselves might not have been sufficient. VW AG’s CEO also could be a control person of VWGoAF for mostly the same reasons, although his signature on certain financials that predated the offering memorandum could not be used to allege control person status.

The case is No. 15-md-02672.

Attorneys: Jeffrey Dubbin (Labaton Sucharow LLP) for BRS. P. Arley Harrel (Williams Kastner) and Gerard Cedrone (Lavin, O'Neil, Cedrone & DiSipio) for Volkswagen Group of America. Matthew H. Marmolejo (Mayer Brown) and Colin H. Tucker (Rhodes Hieronymus Jones Tucker & Gable PLLC) for Audi of America, Inc. Elizabeth L. Deeley (Kirkland & Ellis LLP) for Volkswagen AG.

Companies: Volkswagen Aktiengesellschaf; Volkswagen Group of America, Inc.; Volkswagen Group of America Finance, LLC; Puerto Rico Government Employees and Judiciary Retirement Systems Administration

MainStory: TopStory CorporateFinance CorporateGovernance CorpGovNews GCNNews DirectorsOfficers FraudManipulation InternationalNews PrivatePlacements PublicCompanyReportingDisclosure RiskManagement SecuritiesOfferings CaliforniaNews

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