The Defeat Device: Compliance and Ethics in the Auto Industry

Thomas Fox - Compliance Evangelist
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Things are seriously bad when one of the world’s most respected business focused publications, the Financial Times (FT), asks if the auto “industry faces ‘Libor moment’”? Yet that was a headline yesterday in the lead article in the FT about the still expanding crisis involving the auto manufacturer Volkswagen (VW) and its emission test cheating that has come apart over the past few days. Last week, the US accused VW of rigging its 500,000 American diesel cars so they would pass emissions requirements when being tested yet belch out 30%-40% more pollution when in actual operation. VW accomplished this through software that could distinguish between testing and operation.

What do you think the chances are that VW was not aware that the ‘defeat device’ software was in its vehicles? Anyone out there think that VW negligently installed and upgraded software through multiple product lines for over 6 years in upwards of 11 million autos? If you do it may be time for a very long session on the meaning of the word intentional. 

However the world was stunned this week when not only VW admitted that it had installed software to provide incorrect data on emissions tests around its diesel vehicles in the US but, as reported in the online publication Slate, “the German car manufacturer announced that 11 million of its cars were fitted with diesel engines that had been designed to cheat emissions standards.” Obviously the culture of the company comes into serious question when such a worldwide, multiyear, systemic plan is designed and implemented to break the law.

As further reported in the FT in another article, entitled “VW woes cast doubt over chief’s place in driving seat”, Chris Bryant and Andy Sharman reported that Martin Winterkorn, VW chief executive wrote that he ordered an external investigation and quoted him for the following, “We do not and will not tolerate violations of any kind of our internal rules or the law.” However the article also quoted Ferdinand Dudenhoeffer, an automotive expert at the University of Duisburg-Essen, for the obvious, “Either Winterkorn knew about [the cheating] and should resign, or he didn’t know, and should resign anyway.”

The financial cost to VW has been dramatic and immediate. The company’s stock lost 20% of value in one day, erasing some €13bn of VW capitalization of company capitalization. While the company announced it had reserved some €6.5bn for repairs; the potential US fines can range as high as $37,500 per car under the Clean Air Act which would be a total upwards of $18bn. But in addition to the repair costs, there is the cost for diminution of value of each car so there is already at least one class action suit on file. That does not even begin to take into account the inevitable shareholder actions against the company management.

What about criminal sanctions as the Wall Street Journal (WSJ) reported, in an article entitled “U.S. Begins Criminal Probe of VW” by William Boston, that a criminal probe has begun. One might think after the recent General Motors (GM) settlement through a Deferred Prosecution Agreement (DPA) of their liability in the ignition switch scandal in which people actually died, VW would have little to fear for some pollution. However, hell hath no fury like a Justice Department criticized for a too lenient settlement when a foreign manufacturer is now in its sights. If I were a senior executive at VW right now, I would be lawyering up, because after the GM settlement with no individual prosecutions – and most especially after the release of the Yates Memo – the Department of Justice (DOJ) will certainly be looking to prosecute individuals who had a hand in polluting America’s air.

Not surprisingly, most of the world’s auto manufacturers took pains to immediately distance themselves from the actions of VW. However, I think it may be fair to suspect that the Environmental Protection Agency (EPA) and its European Union (EU) based brethren will be increasing their testing of all diesel autos regardless of the manufacturer because, as the FT noted, “The sight of a US regulator alleging that VW, a European car maker, has cheated during pollution measuring tests raises an uncomfortable question for EU authorities.”

The VW case may well bookend with the GM case about what happens when compliance and ethics are not taken seriously within an organization. What does it tell you that a company can have a worldwide, multiyear scheme in place to not only defraud the consuming public but also lie to government regulators in the actual reporting? Does the Siemens Foreign Corrupt Practices Act (FCPA) scandal ring any bells here?

Moreover, if a company had so little regard for ethical behavior that it engaged in such conduct for over six years, do you think that attitude may bleed over into any other areas of business? How about anti-corruption compliance? After all, VW did sell only 500,000 of those 11 million diesel autos here in the US. Do you think the Securities and Exchange Commission (SEC) might be interested in testing VW’s internal controls about now? Could VW have engaged in other intentional conduct that may well have violated the FCPA?

So is the FT right, that the auto industry might face a Libor moment? Only time will tell but I would hope that every compliance officer at every similarly situated auto company is pulling back the sheets to look at such questions and, more importantly, that they are being supported by senior management in their compliance inquiries. It is certainly one thing for management to ask what did you find when you go looking but it is another question for management to say why are you looking? If you face such an attitude, it may well be time for you, as a Chief Compliance Officer (CCO) or compliance practitioner, to consider moving on before any regulators come knocking.

The VW emissions scandal will be with us all for quite sometime into the future. Where VW comes out in this will in large part depend on the actions they take in the very near future. One suggestion I have is that the SCCE’s annual Compliance and Ethics Institute will be held next month from October 4-7. VW senior management might want to attend and sign up for all the sessions which have the word ETHICS in the title.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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