The news that Volkswagen employed sophisticated software-based “defeat devices” in order to permit a number of its diesel-engine models to appear to meet U.S. emissions standards has dominated the headlines in the business pages over the last few days. The news has already led to the resignation of its embattled CEO, Martin Winterkorn. In addition to regulatory enforcement proceedings, the company faces possible criminal action as well as a host of consumer lawsuits. In addition, on September 25, 2015, plaintiff’s lawyers filed a securities class lawsuit in the Eastern District of Virginia against VW, its U.S. operating divisions, and certain of its directors and officers, on behalf of investors who purchased VW’s American Depositary Receipts (ADRs) in the United States. As discussed below, there are a number of interesting features to this new securities lawsuit. In addition, as also discussed below, a Dutch investors’ association has separately initiated an effort under Dutch collective action statutory provisions to pursue claims against VW, as well.
On September 18, 2015, the U.S. Environmental Protection Agency issued a press release (here) announcing it was serving a notice of violation on VW and its U.S. operating units, alleging that in approximate 482,000 diesel-engine VW and Audi vehicles the company had employed sophisticated software to circumvent EPA admissions standards for air pollutants. The software detects when the vehicle is undergoing an admissions test, triggering the operation of the vehicle’s full emissions controls, greatly reducing the vehicle’s air pollution emissions. This arrangement allowed the vehicles to meet emissions standards in the laboratory, but during normal operation the vehicles nitrogen oxide emissions were up to 40 times the standard. That same day, the California Air Resources Board also issued an in-use compliance letter to the auto manufacturer.
On September 25, 2015, Germany’s transport minister reported that VW had rigged emissions tests on an additional 2.8 million vehicles in Germany, nearly six times as many as the company had admitted to falsifying in the U.S. That same day, after appointing a new CEO, the company announced its Supervisory Board had authorized U.S. and German lawyers to conduct an independent investigation of the actions within the company that led to the installation of the emissions testing “defeat devices” in the company’s vehicles.
All of these developments came just days after the company’s September 11, 2015 press release in which the company announced that it was the “world’s most sustainable automotive group,” citing an independent group’s award of high marks to the company “in the areas of codes of conduct, compliance and anti-corruption as well as innovation management, climate strategy, and life cycle assessment” and for the company’s role as benchmark-setting industry member for “supplier management and environmental reporting.” That’s what you call ironic. (Hat to Chad Heminway of Advisen for identifying the company’s sustainability press release.)
Interestingly, the California environmental enforcement agency said in its September 18, 2015 notice letter that VW had admitted its use of a defeat device in its vehicles to regulators on September 3, 2015, several days before the company’s self-congratulatory press release about its “sustainability” achievements.
As might be expected, consumer lawsuits have quickly followed the news about the environmental enforcement actions. Within days of the news, Reuters was reporting (here) that there were already over two dozen consumer class action lawsuits in the U.S. filed on behalf of car owners who had purchased the affected vehicles, and NPR’s latest tally is that there are 34 lawsuits and maybe more. These consumer claims are different in kind and character than previous consumer class action lawsuits filed against automobile manufacturers, in that these circumstances do not involve passenger deaths or even accident-related vehicle damage. The plaintiffs’ lawyers apparently intend to pursue damages claims on several different theories: first, that the vehicle owners are entitled to compensation because the diesel-powered vehicles cost several thousand dollars more than gasoline powered cars; second, because the anticipated costs of operating these vehicles will be higher in the future; and third, because the vehicles will have lower resale values.
Several states attorneys general have announced that they are launching their own investigations of the circumstances surrounding the emissions scandal.
The company faces the prospect of massive civil penalties. The EPA can impose fines of up to $37,000 for every vehicle for Clear Air Act violation, which would equate to a total penalty of about $18 billion. The Clean Air Act also authorizes criminal prosecution for tampering with “any monitoring device or method” required for tacking emissions. There are numerous press reports that the U.S. Department of Justice has launched an investigation of the company. In addition, in a September 23, 2015 press release (here), Volkswagen reported that the Executive Committee of Volkswagen’s Supervisory Board had authorized the company to submit a complaint to the State Prosecutors’ office in Brunswick. Wayne State University Law Professor Peter Henning has an interesting September 24, 2015 post on his New York Times White Collar Watch blog (here) analyzing the potential criminal consequences for Volkswagen from the emissions scandal.
The U.S. Securities Class Action Lawsuit
A local police pension fund has now launched a securities class action lawsuit in the Eastern District of Virginia against the company, its U.S. operating units and seven of the company’s current and former directors and officers. The lawsuit, which was filed on behalf of investors who purchased the company’s sponsored ADRs in the United States between November 19, 2010 and September 21, 2015, seeks to recover damages for alleged violations of the Securities Exchange Act of 1934.
According to the plaintiff’s lawyer’s press release, the complaint alleges that the defendants “misled investors by failing to disclose that the Company had utilized a ‘defeat device’ in certain of its diesel cars that allowed such cars to temporarily reduce emissions during testing, while achieving higher performance and fuel economy, as well as discharging dramatically higher emissions, when testing was not being conducted. The use of this device allowed Volkswagen to market its diesel vehicles to environmentally conscious consumers, increasing its sale of diesel cars in the United States and abroad and, as a result, its profitability.”
The plaintiff’s lawyers chose to file their securities lawsuit in the Eastern District of Virginia because that is where VW’s U.S. unit is headquartered. However, not uncoincidentally, the Eastern District of Virginia also happens to be the so-called Rocket Docket court, which has the shortest average time from filing to resolution of civil actions of any U.S. district court. In other words, we are not going to have to wait long to see how this case will turn out.
Assuming for the sake of discussion that the case survives a motion to dismiss, it will be interesting to see how valuable this U.S.-based securities case turns out to be for the plaintiff class. Although VW’s market cap is over $50 billion (even after the recent 30% drop in the company’s share price), only a small fraction of its securities trade as ADRs in the U.S. Indeed, only a very small fraction of its overall shares are held by private investors. Over half of the company’s shares are owned by the Porsche family, another twenty percent is owned by the state of Lower Saxony, and seventeen percent is held by the sovereign wealth fund of Qatar. The investing public holds only about 12 percent of the company, of which the U.S. ADRs represent only a small fraction.
Because of the restrictions described by the U.S. Supreme Court in its 2010 decision in Morrison v. National Australia Bank, the U.S. securities laws apply only to investors who purchased their shares on U.S. exchanges and to domestic transactions in other securities – which explains why the plaintiff’s lawyers here filed the lawsuit only on behalf of U.S. ADR investors.
The interesting thing about that is that the VW ADRs trade only over the counter (OTC), not on an exchange. The fact that the ADRs only trade over the counter wouldn’t seem to matter because the investors’ purchase of the ADRs would still seem to meet Morrison’s second prong, referring to domestic transactions in other securities.
However, the extent of applicability of the U.S. securities laws to unlisted ADR transactions is one of those interesting questions that has continued to trail along after the U.S. Supreme Court’s Morrison decision. At least one federal judge has held in light of Morrison that the U.S. securities laws do not apply to unlisted ADR transactions (refer here for a discussion of Judge Berman’s September 2010 decision in the Société Générale case). This same issue has come up in a number of other recent U.S. securities suits involving non-U.S. companies whose unlisted ADRs trade over the counter in the U.S., including in particular in connection with the U.S. securities suit filed against Tesco and certain of its directors and officers. This is an issue that will have to be sorted out in this case as well.
In light of these concerns and in light of the fact that a significantly greater portion of the company’s share ownership is held as a result of transactions on the Frankfurt stock exchange, it will be interesting to see if investors seek to pursue securities claims against the company and its directors and officers in German courts, under German law. However, claimants seeking to pursue securities law claims under German law using the procedures detailed in the KapMuG statutory provisions have not enjoyed noteworthy success.
Of perhaps greater interest for a different set of VW investors is the initiative of the Netherlands-based investors’ association VEB, which on September 25, 2015 announced (here) that it has initiated a liability claim under Dutch law on behalf of VW shareholders who purchased their shares through a Dutch bank or broker. The group said in its announcement that it issued the liability claim “in order to be able to represent Dutch and European investors who acted through a Dutch bank or broker in a possible lawsuit.” VEB also said that it has “invited Volkswagen to discuss possible compensation for the losses incurred by these investors.” As discussed here, in 2012, the Amsterdam Court of Appeals approved of a collective settlement of securities claims against Converium and held that the settlement was binding even though the company involved was not based in the Netherlands and the shares represented in the collective action settlement had not been purchased on a Netherlands exchange. As discussed here, a group of Tesco shareholders is attempting to organize a similar action in the Netherlands against the UK-based grocery store chain (which is distinct from the separate effort to organize a collective action in the UK).
The proposed Dutch action that VEB is organizing will be of interest to some VW shareholders, but as framed by VEB, the potential benefit of the action would be limited to those who purchased their shares through a Dutch bank or broker, which would obviously omit from any collective settlement the bulk of VW investors.
In thinking about potential liability issues involved here, it is important to note that in the wake of the emissions scandal, there has been a great deal of criticism of VW’s supervisory board, as evidenced, for example in the September 25, 2015 New York Times article entitled “Problems at VW Start at the Boardroom” (here). As the article details, the company’s supervisory board is dominated by the Porsche family and otherwise populated by representatives of the other large shareholders, the state of Lower Saxony and the Qatar sovereign wealth fund. This composition would seem to make it unlikely that the supervisory board would pursue a breach of fiduciary duty claim against the company’s management board, under the procedures contemplated in the company’s corporate laws defining the country’s dual-board governance standard.
There is a possible approach based on a prior German corporate scandal that might allow the company to achieve the same outcome as a lawsuit might permit but without the need for the supervisory board to actually pursue claims against the members of the management board. As discussed here, in 2009, Siemens reached a 100 million euro settlement with its D&O insurers, in resolution of potential corruption-related claims the company’s supervisory board could have filed against the company’s management board. The settlement was the result of negotiations between Siemens and its D&O insurers and reflected the parties’ compromise of the D&O insurers’ potential coverage defenses. In connection with the settlement, several individual former Siemens directors and officers agreed to make substantial settlement contributions out of their personal assets. The Siemens case provides a possible template for an approach that the VW supervisory board might try to take with respect to any arguable claims that the supervisory board might otherwise pursue against the company’s management board.
The company’s D&O insurer’s willingness to entertain the discussion of a settlement of this kind would likely be substantially affected by the extent of the success of the U.S. securities lawsuit, as well as the extent to which the policy’s proceeds are called upon for purposes of provide individuals with a defense to the prospective criminal proceedings.
Another issue that potentially could affect the availability of D&O insurance coverage is the fact that the company has admitted that it used the defeat devices to rig the emissions tests. But though the company has admitted wrongdoing, so far all of the company’s senior officials have denied knowledge of the emissions testing misconduct. In addition, a D&O insurance policy’s fraudulent or criminal misconduct exclusion typically is only triggered if there has been an adjudication or judicial determination that the precluded conduct took place, so all else equal the fact that the company has publicly admitted the emissions testing wrongdoing would not necessarily affect the availability of coverage under the company’s D&O insurance policies. In addition, even if the prospective criminal proceedings result in convictions against one or more company officials, the verdict or guilty plea likely would only affect the availability of insurance for the convicted individual.
Where things could get interesting would be if VW were, as General Motors recently did in connection with the U.S. auto manufacturer’s ignition switch scandal, to enter into a plea agreement with prosecutors in which the company admits to wrongdoing. Were that to happen, the company could, depending on how the plea agreement or other case resolution was framed, result in the preclusion of coverage under the policy for the company itself.
In any event, the new U.S. securities lawsuit filed against VW and certain of its directors and officers does reflect a number of recent securities class action lawsuit filing trends.
For starters, it represents yet another example of a securities lawsuit filed against a company in the wake of environmental enforcement-related problems at the defendant company. As I noted in a recent post (here), during the financial crisis, environmentally-related securities lawsuits fell off the radar screen for a while, and more recently attention-grabbing D&O lawsuits like claims relating to cyber security issues have attracted all of the attention, but environmentally-related issues have been and remain an area of focus for plaintiffs’ attorneys.
In addition, the lawsuit against VW also represents the latest U.S. securities class action lawsuit filed against a non-U.S. company. Securities suit against foreign companies have been and remain a significant component of all securities suits filed in the U.S. In 2014, suits against non-U.S. companies represented 19% of all U.S. securities suit filings during the year. This trend has continued in 2015, as the 28 lawsuits filed so far against non-U.S. companies represent 19.5% of all securities class action lawsuits filed this year. Non-U.S. companies represent only about 16% of all companies listed on U.S. exchanges, so the involvement of non-U.S. companies in U.S. securities class action litigation is disproportionately greater than their representation on the U.S. exchanges.
The lawsuit against VW is also the latest example of a case in which a prominent non-U.S. company caught up in a high-profile scandal has become ensnared in U.S. securities litigation. Other prominent recent examples include Tesco, Toshiba and Petrobras. In each case, the vast proportion of shares of the companies involved trade outside of the U.S., making it much more difficult for the bulk of affected investors to seek to pursue damages for their losses. In many of these cases, the investors who purchased their securities in the U.S. will likely be able to recover on their losses, while the investors who purchased their shares on exchanges in the countries’ home countries may go empty-handed.