Securities Regulation Daily SEC charges Volkswagen and former CEO with defrauding investors in ‘clean diesel’ emissions scam
Friday, March 15, 2019

SEC charges Volkswagen and former CEO with defrauding investors in ‘clean diesel’ emissions scam

By Joanne Cursinella, J.D.

The SEC has filed a complaint charging Volkswagen AG, two of its subsidiaries, and its former CEO with defrauding U.S. investors, raising billions of dollars through the corporate bond and fixed income markets while making a series of deceptive claims about the environmental impact of the company's "clean diesel" fleet.

The Commission has filed a complaint in the Northern District of California charging Volkswagen Aktiengesellschaft (VW) its former CEO, and two of its subsidiaries with a "massive fraud" scheme by repeatedly misleading U.S. investors, consumers, and regulators as part of an illegal scheme to sell its purportedly "clean diesel" cars and billions of dollars of corporate bonds and other securities in the United States. The Commission claimed that VW marketed these bonds and other securities without disclosing that its "clean diesel" cars used defeat devices to conceal substantial emissions problems (SEC v. Volkswagen Aktiengesellschaft, March 14, 2019).

Massive fraud alleged. According to the SEC’s complaint, VW’s CEO, and other VW executives were made aware of the defeat devices as early as November 2007, during a meeting with VW engineers, to discuss the emissions problems with VW’s "clean diesel" vehicles. VW subsequently sold hundreds of thousands of "clean diesel" vehicles in the U.S. containing the defeat device while raising billions of dollars from U.S. investors to fund its expanding sales of "clean diesel" cars across the globe, the Commission alleged.

Later, when U.S. authorities began investigating emissions problems with VW vehicles, the company misled government investigators, concocted a sham software fix, and destroyed thousands of incriminating documents and other evidence, the SEC claimed. Eventually, the fraud and cover-up were discovered, and VW eventually pleaded guilty to conspiracy to commit fraud, obstruction of justice, and importing goods by false statements in federal district court.

Strategy 2018. In 2007, the former VW CEO announced a "bold and aggressive" plan to make VW the biggest, most profitable, and most environmentally-friendly car company in the world by 2018, according to the complaint. The plan, called "Strategy 2018" depended on VW’s ability to develop, market, and sell its diesel vehicles, particularly in the U.S. The strategy depended on developing diesel engines that normally emit harmful pollutants into the environment with the accompanying difficulty in complying with U.S. emissions standards, with a "revolutionary" solution—the "clean diesel" engine.

Over the next several years, the plan began to be successful, the Commission alleged. To finance the strategy, VW relied on the U.S. markets for capital. From 2010 to 2015, VW sold billions of dollars of corporate bonds and asset-backed securities in the United States. In its offering documents, VW stressed its continuing commitment to and dependence upon developing energy-efficient vehicles and the reduction of vehicle emissions, assuring potential investors that cars complied with all applicable emissions laws and regulations.

Clean diesel engine fraud. But VW’s "clean diesel" engines were a fraud, the Commission alleged. In fact, the engines emitted pollutants at levels nearly 40-times greater than U.S. emissions limits. To conceal this, VW installed illegal software (called a "defeat device") in 11 million diesel vehicles sold worldwide, the SEC said. The software recognized when a car was being tested on a treadmill then reduced the car’s emissions to legal levels, but under normal driving conditions, it deactivated the car’s emission control system, causing it to emit excessive amounts of noxious gas into the environment.

VW lied and made misleading omissions to conceal the existence of a defeat device, the complaint averred. VW lied about its cars’ compliance with environmental regulations and its commitment to protecting the environment, and VW senior officials knew that the clean diesel engine was a sham, the Commission alleged.

Unraveling. According to the complaint, the scheme began to unravel in March 2014, when researchers released independent results showing that the cars’ emissions when tested while being driven yielded evidence that they were emitting pollutants at levels exceeding legal limits. VW officials chose to cover this up, telling regulators that they didn’t know the cause. And when the discovery of the fraud became inevitable, the SEC said, VW employees began destroying records.

Meanwhile, according to the complaint, between May 2014 and June 2015, VW conducted three separate bond offerings in the U.S., selling over $8 billion of bonds to U.S. investors, and sold over $4.9 billion of asset-backed securities in the U.S. in 2014 and 2015. Eventually, VW’s "clean diesel" fraud and ensuing cover-up collapsed in August 2015, when an employee confessed that VW had been using a defeat device in its "clean diesel" cars. The EPA issued a Notice of Violation, and the price of VW’s bonds and asset-backed securities fell in secondary market trading, and major ratings agencies downgraded VW’s bonds.

Relief for investors sought. Although pleading guilty to three criminal felony counts arising out of its massive "clean diesel" conspiracy, paying the DOJ a $2.8 billion penalty for its crimes, and paying billions more to resolve civil claims brought by the EPA, state attorneys general, and consumers who purchased cars with defeat devices, the company never repaid the hundreds of millions of dollars in benefit it fraudulently obtained from the sale of its corporate bonds and ABS, the Commission said.

The Commission, therefore, is bringing this civil enforcement action seeking permanent injunctions, disgorgement with prejudgment interest, and civil penalties against the corporate defendants, as well as permanent injunctions, civil penalties and an officer-and-director bar against the former VW CEO because of their alleged violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.

"Issuers availing themselves of American capital markets must provide investors with accurate and complete information," said Stephanie Avakian, co-director of the Division of Enforcement, in a press releaseannouncing the action. "As we allege, Volkswagen hid its decade-long emissions scheme while it was selling billions of dollars of its bonds to investors at inflated prices."

Attorneys: Daniel J. Hayes for the SEC.

Companies: Volkswagen Aktiengesellschaft; Volkswagen Group of America Finance, LLC; VW Credit, Inc.

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