In re Volkswagen "Clean Diesel" Marketing, Sales Practices, & Products Liability Litigation
Docket: MDL No. 2672 CRB (JSC)
Court: District Court, N.D. California; June 28, 2017; Federal District Court
The court issued an order partially granting and partially denying the defendants' motions to dismiss the First Amended Consolidated Securities Class Action Complaint related to Volkswagen's use of a "defeat device" in approximately 600,000 TDI diesel vehicles sold in the U.S. After Volkswagen’s admission in September 2015, purchasers of Volkswagen-sponsored Level 1 American Depository Receipts (ADRs) initiated actions under the Private Securities Litigation Reform Act (PSLRA), leading to the appointment of Arkansas State Highway Employees’ Retirement System (ASHERS) as Lead Plaintiff in January 2016.
Volkswagen AG pled guilty in March 2017 to multiple felony counts, including conspiracy to defraud and violations of the Clean Air Act. The court had previously dismissed certain aspects of the Original Complaint in January 2017 but allowed the plaintiffs to file an Amended Complaint to address identified deficiencies. The defendants filed motions to dismiss this Amended Complaint, which the court reviewed during a hearing in June 2017.
The court granted the motions in part and denied them in part, refusing to allow amendments for the dismissed portions. The Lead Plaintiff seeks representation for all individuals who purchased Volkswagen-sponsored Level 1 ADRs between November 19, 2010, and January 4, 2016. The defendants include Volkswagen AG, Volkswagen Group of America, and several key executives. The plaintiffs allege violations of Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5 due to misleading statements about Volkswagen's financial status and emissions compliance, claiming they purchased ADRs at inflated prices that subsequently plummeted following the exposure of the company's misconduct.
Key findings from the court's January 4 order include the affirmation of the claims' territorial reach under Section 10(b), the rejection of forum non conveniens arguments, establishment of personal jurisdiction over certain defendants, and adequate pleading of Section 10(b) and Section 20(a) control-person claims against specific individuals.
The Court ruled against the Plaintiffs in its January 4 Order, determining that the Original Complaint did not substantiate claims that VW AG understated its financial liabilities in its financial statements during the Class Period, that Diess acted with scienter in approving the Third Quarter 2015 Interim Report, or that either Diess or Horn qualified as control persons under Section 20(a) of the Exchange Act. Following this, Plaintiffs filed an Amended Complaint on February 3, 2017. In response, the Defendants filed two motions to dismiss, asserting that the Amended Complaint failed to address the four identified deficiencies.
The legal standard for dismissal under Rule 12(b)(6) requires that a claim is plausible, meaning the allegations must allow for a reasonable inference of liability. This standard is heightened for fraud claims under Rule 9(b) and the PSLRA, necessitating particularity in alleging misleading statements and the reasons they are deemed misleading, as well as a strong inference of scienter. If pleadings are insufficiently specific or do not raise a strong inference of wrongful conduct, the Court may dismiss the complaint.
While Plaintiffs argue that the Amended Complaint resolves the noted deficiencies, the Court will evaluate each claim. Specifically, the Plaintiffs allege that VW AG and Winterkorn intentionally or recklessly misstated financial liabilities related to emissions fraud in all financial statements during the Class Period, with Winterkorn signing all but one of these statements. The Court intends to address the allegations concerning Diess's involvement subsequently.
Recognition of provisions and contingent liabilities for German companies, such as VW AG, is governed by IAS 37. A company must recognize a provision if it is probable that an outflow of resources will be needed to settle a present obligation due to a past event, with "probable" defined as a likelihood greater than 50%. If this threshold is not met, a contingent liability must be recognized for obligations where the chance of an outflow is more than "remote." Plaintiffs argued that provisions were necessary for VW AG throughout the Class Period due to the high likelihood of discovering defeat devices and incurring significant liabilities. However, the Court found insufficient factual allegations to conclude that VW AG knew or should have known that losses were probable during the Class Period. Notably, while the Plaintiffs referenced potential fines from the EPA and CARB, the earliest indication of these fines was not until May 2014, contradicting the assertion of VW AG's prior knowledge. The Court stated that the allegations did not support a finding of Section 10(b) liability for VW AG based on its financial statements during the Class Period. Plaintiffs claimed that the Amended Complaint included specific facts showing VW AG's awareness of probable losses no later than May 2014. Nonetheless, the Court determined that even with these additional allegations, there was no support for the assertion that VW AG knew or should have known of probable losses throughout the Class Period. The first financial statement issued during this time was the 2010 Annual Report, which indicated that management was likely aware of the illegal defeat device used in affected vehicles, but did not establish that they knew losses were probable.
From May 2006 to November 2015, Volkswagen AG (VW AG) and its supervisors were aware that certain vehicles did not comply with U.S. emissions standards and were using software to circumvent testing procedures. However, they concealed this information from U.S. regulators and customers. The supervisors understood that revealing the defeat device would prevent VW from obtaining necessary certifications for these vehicles. Despite this knowledge, the allegations do not indicate that VW AG recognized the likelihood of financial losses related to the defeat device at the onset of the Class Period. The assertion that VW AG knowingly employed an illegal device does not equate to an awareness of imminent consequences or investigations by regulatory agencies at that time. Prior cases, such as In re Citigroup and Gusinsky v. Barclays PLC, illustrate that companies are not required to self-report wrongdoing unless there is a clear indication of ongoing investigations or the likelihood of liability is more than remote. Thus, VW AG's obligation to disclose potential penalties would only arise with the initiation of an investigation, not simply from the knowledge of deception. The court's reasoning emphasizes that awareness of potential legal issues does not necessitate immediate recognition of financial liabilities in statements. Additionally, while a warning from the California Air Resources Board (CARB) in 2008 about potential penalties was noted, it does not alter the overall conclusion regarding disclosure obligations.
The allegation against Volkswagen (VW AG) stems solely from a report by the German newspaper Süddeutsche Zeitung, which lacks context regarding a warning from the California Air Resources Board (CARB). It is unclear if the warning was directed specifically at Volkswagen or was a general industry alert. If it was general, it would not imply VW's awareness of using a defeat device. The plaintiffs fail to identify who at VW AG was aware of the CARB warning, undermining claims that senior executives, including Winterkorn, recognized any probable losses associated with the defeat device at the start of the Class Period. Corporate scienter is heavily dependent on the knowledge of directors and officers, and the doctrine of collective scienter does not apply as the alleged misstatements were not significantly false enough to suggest that any corporate officials were aware of their falsity. Consequently, the plaintiffs do not convincingly argue that VW AG or Winterkorn intentionally or recklessly misstated financial statements during the Class Period.
Additionally, plaintiffs argue that by May 2014, VW AG and Winterkorn should have recognized that losses related to the defeat device were probable. The court noted that previous allegations supported this inference. Following the revelation of emissions issues in May 2014, prompted by a study from West Virginia University and commissioned by the International Council on Clean Transportation, there was notable internal activity at VW concerning the study and subsequent investigations by the EPA and CARB. Notably, a VW task force presented findings related to potential financial consequences if the defeat device was uncovered, and on May 15, 2014, Defendant Horn received a letter warning about the impact on 500,000-600,000 affected vehicles and detailing specific fines per violation, emphasizing the seriousness of the situation.
Horn was aware as early as May 20, 2014, that Volkswagen's illegal practices could incur fines between $21.5 and $25.8 billion from the EPA and CARB, as indicated in the Horn letter. In spring 2014, Gottweis communicated the seriousness of the situation to Winterkorn, who acknowledged knowledge of high emissions levels in TDI vehicles by May 2014. On May 23, 2014, Gottweis presented a memo to Winterkorn outlining the emissions fraud, asserting that excessive emissions and the defeat device had no legitimate explanation and warning that authorities would investigate Volkswagen's systems. These events suggest that by the end of May 2014, senior executives at both VWGoA and VW AG were aware of the ongoing investigation, the potential financial repercussions, and that the excessive emissions levels were likely due to the defeat device. This awareness raises the implication that Winterkorn, as CEO, knew of significant probable losses related to the fraud, which should have been reflected in financial statements. Defendants argue that a March 2, 2016 VW AG press release indicating a belief that the diesel issues could be resolved by a minor fine contradicts the May 2014 liability estimates. However, the existence of differing estimates does not negate the inference that VW AG was aware of the potential losses by May 2014. Furthermore, given the number of affected vehicles and the potential fines per vehicle, a reasonable conclusion could be drawn that the later press release provided an inaccurate and overly optimistic assessment of the situation.
A court evaluating a motion to dismiss must accept the factual allegations in the complaint as true and draw reasonable inferences in favor of the nonmoving party. The Plaintiffs’ Amended Complaint suggests that by the end of May 2014, Winterkorn and VW AG were aware or should have been aware of the likelihood of losses due to emissions fraud, leading to intentional or reckless misstatements in financial statements issued after May 2014. However, the allegations do not sufficiently support that losses were probable before May 2014, thus failing to establish intentional or reckless misstatements for earlier financial statements.
Additionally, the Plaintiffs allege that Diess made material misrepresentations in VW AG’s Second and Third Quarter 2015 Interim Reports by understating total liabilities. The Court found sufficient evidence of scienter for the Second Quarter 2015 report but not for the Third Quarter, as this report disclosed initial exceptional charges of €6.7 billion for diesel issues, indicating that any misjudgment regarding liability amounts was likely not an act of concealment.
Further allegations in the Amended Complaint indicate Diess was aware of Volkswagen's use of defeat devices by July 2015 and that the company estimated $26 billion in exposure from the emissions cheating prior to the Third Quarter report. Despite Diess's awareness of the estimate, the Court concluded this does not imply he intentionally or recklessly misstated the emissions-related charge in the Third Quarter report. The Court must also consider plausible nonculpable explanations for Diess's actions, such as viewing the €6.7 billion charge as initial and subject to adjustment based on further legal evaluations.
The Third Quarter 2015 Interim Report identified a €6.7 billion charge as an “initial exceptional charge” related to legal risks from the diesel emissions issue, indicating that Volkswagen AG (VW AG) was transparent about the potential for further liabilities. This transparency undermines allegations of fraudulent intent by Diess, as the evidence suggests he did not attempt to conceal the total liability. Consequently, the plaintiffs failed to establish a strong inference of scienter regarding Diess's alleged misstatements in the report.
For control-person claims under Section 20(a) of the Exchange Act, plaintiffs must demonstrate both a primary violation of federal securities laws and that the defendant had actual control over the violators. While the court previously found adequate allegations against other corporate defendants, it held that plaintiffs did not sufficiently plead Diess's control over the alleged violators. In their Amended Complaint, plaintiffs claimed Diess was aware of the defeat devices and signed the interim reports, but these claims did not substantiate the necessary control over day-to-day operations. Unlike a precedent case where the CEO was actively involved in management, Diess's role did not meet the threshold for control-person liability, resulting in a lack of sufficient allegations to support claims against him, while claims against Horn were deemed sufficient.
Horn Plaintiffs initially claimed Horn had significant control over VWGoA and VWoA, directing their public statements and regulatory actions. However, the Court found these allegations inadequate for establishing control-person liability due to a lack of specific details regarding Horn's control. The Amended Complaint provided additional background on Horn, noting his extensive experience with VW AG and his role in revitalizing VWGoA’s U.S. strategy after declining sales. Despite this, the Court ultimately determined that the amended allegations sufficiently demonstrated Horn’s active involvement in day-to-day operations and his power to control corporate actions. For instance, he was implicated in the approval processes for selling vehicles in the U.S. and was involved in responding to regulatory issues, including the ICCT report. His position as CEO of VWGoA and his testimony before Congress regarding the diesel scandal further supported claims of his authority and oversight. Additionally, the Volkswagen Defendants sought reconsideration of the Court's prior findings regarding collective scienter and ultimate authority over false statements, but the Court denied this request, noting no changes in controlling law or clear errors in its previous rulings.
The Court's conclusions are as follows:
1. Volkswagen's motion to dismiss the Plaintiffs' Section 10(b) claim is granted regarding alleged intentional or reckless understatement of financial liabilities in quarterly and annual financial statements issued before May 2014.
2. The motion is denied for statements issued after May 2014.
3. The motion is also granted concerning claims against Diess related to the Third Quarter 2015 Interim Report.
4. Volkswagen's motion to dismiss the Section 20(a) control-person claim against Diess is granted.
5. Horn's motion to dismiss the same claim against him is denied.
6. Volkswagen's request for reconsideration of previous rulings is denied, as the Court previously allowed Plaintiffs to amend their Complaint to address deficiencies noted in earlier orders. Plaintiffs have not indicated any new material allegations they could provide if allowed to amend again, leading to the denial of further leave to amend.
Additionally, Jonathan Browning, previously named as a defendant, was not included in the Amended Complaint due to insufficient allegations of scienter. The Court noted that six senior executives were implicated in VW AG's criminal plea agreement, which acknowledged their misconduct. The Court did not ascertain a specific date in May 2014 when scienter became compelling due to the timing of relevant reports. Allegations from the Second Superseding Indictment against former VW AG executives were not used to establish facts for scienter but were considered to corroborate admissions in the Statement of Facts from the plea agreement.
