How the massive diesel fraud incinerated VW s reputation ... · How the massive diesel fraud incinerated VW s reputation and will hobble the company for years to come. PHOTO ILLUSTRATION

How the massivediesel fraud

incinerated VW’sreputation—and willhobble the company

for years to come.

P H O T O I L L U S T R A T I O N B Y J U S T I N M E T Z

By Geoffrey Smithand Roger Parloff

March 15, 2016 FORTUNE.COM 99

100 FORTUNE.COM March 15, 2016

n late 2008 a publication calledGreen Car Journal compared thefive finalists of its annual GreenCar of the Year award. “Fulfillingthis growing desire for vehicleswith better fuel economy andoverall environmental perfor-

mance is no easy thing,” it noted. “Rising to the top is the2009 Volkswagen Jetta TDI.” The car was the winner be-cause its “groundbreaking clean diesel” engine managedto meet America’s “stringent tailpipe emissions stan-dards” while also delivering “admirable fuel efficiency,”“satisfying performance,” and “a very reasonable” price.

T H E V W S C A N D A L


In part, the huge number of suits reflects the factthat plaintiffs lawyers smell blood. Volkswagen hasalready made public admissions that come closeto conceding legal liability. “This is not a whodunittype of case,” said federal judge Charles Breyer, whois overseeing the litigation, at a hearing in January.

The numbers also reflect genuine rage at VW.An extraordinary number of educated middle-classor affluent plaintiffs feel deliberately snookered ona subject they are passionate about. Unlike in Eu-rope, where more than half the cars are diesels, theyare rarities in the U.S.—about 0.5%—and they costmore than gasoline-powered models. Accordingly,Americans chose them specifically for a trait thatturned out to be a lie. Says Cabraser: Diesel buyersare “looking for the sweet spot between high mile-age, performance, and environmental responsibil-ity. They read Consumer Reports, do comparisonshopping, do the math. They were highly investedin these vehicles…They were attempting to protectand preserve the environment.”

Volkswagen has set aside 6.7 billion euros($7.3 billion) to make its cars comply with emis-sions rules—but the sum doesn’t begin to take intoaccount the fines, compensation, restitution, andattorneys’ fees the company will eventually have tofork over. U.S. regulators rejected VW’s first recallproposals in December, and at press time it was stillnot at all clear whether they’ll ever approve “fixes”for many U.S. cars, or whether they will demand VWbuy them back instead. In late February an angryJudge Breyer twisted the vise even tighter, orderingthe company to determine, by March 24, whether itcan fix the cars.

VW has skidded into the guardrails at everyturn since the scandal emerged. Even its attemptsto project contrition so far have been ham-fisted,halfhearted, and fumbled. CEO Martin Winter-korn quickly resigned, top executives apologized,a number of engineers were suspended, and thecompany appointed an American law firm, JonesDay, to perform an internal investigation.

But the company’s new worldwide CEO, Mat-thias Müller, infuriated regulators with legalistic

That award was recently rescinded. The Jetta—like at least14 other so-called Clean Diesel models sold by VolkswagenGroup under its VW, Audi, and Porsche marques from 2008to 2015—was actually the automotive equivalent of PiltdownMan. It was a hoax.

About 580,000 VWs in the U.S.—and almost 10.5 millionmore worldwide—weren’t really “green” at all. As the worldbegan to learn in September, when the U.S. EnvironmentalProtection Agency issued a shocking “notice of violation,” thevehicles met emissions standards for dangerous oxides of nitro-gen, known collectively as NOx, only when running their pacesin an artificial, indoor lab setting. Volkswagen has admittedthis. Software in the engine recognized the telltale signs of thetesting regimen and turned up the emissions-reduction equip-ment when its exhaust was under scrutiny. But once the carwas driven onto actual roads, the equipment adjusted and thevehicle disgorged up to 40 times the permissible levels of NOx.

For seven years Volkswagen’s advertising campaignsflogged these vehicles’ bogus eco-friendly credentials in print,media, and even Super Bowl commercials. In one memorableexample, the “green police” stop a long line of smog-belchingcars but wave a lone, righteous diesel from VW’s Audi divisionthrough with a cheery, “You’re good to go, sir.”

“Hoax,” of course, is a layman’s word. But plenty of legal termsalso arguably apply, including “consumer fraud” and “false ad-vertising.” They are fueling an explosion of litigation. That andthe horrific reputational damage are subjecting Volkswagen toone of the severest challenges in its nearly 80-year history.

The U.S. Department of Justice and the EPA have filed a civilsuit that could theoretically subject VW to up to $45 billion infines (though, in fairness, no one expects penalties quite thatdraconian). The DOJ and the EPA are also pursuing a criminalinquiry, as are prosecutors in Germany, France, Italy, Sweden,and South Korea. All 50 state attorneys general in the U.S. arealso on the warpath, armed with state laws that, nominally atleast, are every bit as crushing as the federal law.

All of that comes on top of more than 500 class actions filedon behalf of owners and lessors of Volkswagen diesel cars—anunprecedented number, according to Elizabeth Cabraser, a lead-ing mass-disaster plaintiffs attorney who is heading a 22-lawyersteering committee trying to bring order to the sprawling mess.There are also class actions by used car dealers, dealers for com-peting models (such as Chevy diesels and Toyota hybrids) whoclaim unfair competition, and shareholder suits.

It has refused to offer its millions of European customers anycompensation.

In Europe, some think the American reaction to the scandalis overwrought, driven by contingency-fee lawyers and politi-cians eager to help domestic automakers gain ground against aEuropean rival. After all, General Motors paid a comparativelymodest $900 million to settle a federal criminal inquiry relatingto faulty ignition switches that led to the deaths of 124 people.Even the EPA has acknowledged that all diesel cars together ac-count for only about 0.1% of NOx in America’s air supply.

But emissions aren’t a mere abstraction—NOx kills. Consid-er the impact of diesel engines in Europe, where three-quartersof the world’s diesels are sold. According to the European En-vironment Agency, 500,000 people there died prematurely in2012 as a result of poor air quality. The biggest contributorswere nitrogen oxides and cancer-causing particulate matter.Diesel engines are the biggest source of NOx and a significantemitter of particulate matter. (VW flatly denies, in its writtenstatement to Fortune, that NOx represents any proven healththreat. “The scientific data currently known to us does not givea clear picture of the effect of nitrogen oxide in environmentalconcentrations on people and no completely validated state-ments can be made about the actual risk potential.”)

But if the environmental agency’s science is correct, thenthose disturbing numbers point to a broader problem: Europehas favored diesels and looked the other way when automak-ers—including but hardly limited to VW—game the system.Emissions Analytics, a U.K.-based consulting company, saysit has tested the real-world emissions of more than 400 dieselcars. Only five (including one Volkswagen) actually met thestandard they were licensed to, according to CEO Nick Mold-en. “On average, diesels were emitting four times the regulatedmaximum,” he says. “Volkswagen was in the middle of the pack.”

WHO GOVERNS WHOM?it’s difficult to exaggerate how intertwined Volkswagen iswith German institutions—from its government, politicians,and regulators to its unions. It was conceived, of course, byAdolf Hitler, who wanted it to spread mobility to the massesthe way that Henry Ford had done. VW was nationalized afterWorld War II and returned only fitfully to private ownership.

All these decades later, VW remains formally connected tothe government. Lower Saxony, the state where the companyis based, owns 20% of its voting rights, but the state’s power iseven greater than that. By law, Lower Saxony has been grant-ed veto power over VW’s strategic decisions.

Then there are the informal connections: Gerhard

hedging and excuses in an interview with NationalPublic Radio in January. “It was a technical prob-lem,” he told NPR. “We had not the right interpreta-tion of the American law…We didn’t lie. We didn’tunderstand the question first.” (Volkswagen de-clined to make Müller or other executives availablefor interviews. The company answered a handful ofquestions in writing but declined to comment onthe vast majority, stating, “These topics are subjectto ongoing investigation or to privacy protection.”)

VW’s misbehavior did not come out of nowhere.The company has a history of scandals and episodesin which it skirted the law. Each time—till now—ithas escaped without dire consequences.

The company’s immense power, it seems, meantnever having to say it was sorry, at least not in Eu-rope. VW has a legacy as a quasi-state entity thathas long steamrolled regulators there. The companyand the auto industry are so crucial to Germanythat Chancellor Angela Merkel has repeatedly inter-vened to stave off or weaken emission regulations.

VW is driven by a ruthless, overweening culture.Under Ferdinand Piëch and his successors, the com-pany was run like an empire, with overwhelmingcontrol vested in a few hands, marked by a high-octane mix of ambition and arrogance—and micro-management—all set against a volatile backdrop ofepic family power plays, liaisons, and blood feuds.It’s a culture that mandated success at all costs.

Volkswagen’s goals were audacious: It aspiredto be the biggest seller of cars in the world underPiëch protégé Martin Winterkorn. Sales of U.S.diesels were crucial to the mission. The companyhas continually protested that top executives—otherwise noted for their punctilious attention todetail—were ignorant of misbehavior. But the evi-dence suggests, at minimum, that some were alert-ed to possible cheating well before it became pub-lic. Even before that point, one has to wonder howthe brass could have been blind to conduct thatwas so central to achieving the company’s goals.

The company has acknowledged and even apolo-gized for the fact that its diesels used dual-strategysoftware worldwide. (It has largely blamed a hand-ful of rogue engineers.) Yet VW has steadfastly de-nied that its software constituted an illegal “defeatdevice” as the term is defined under European law.



smo

ke: a

nta

ga

in—

ge

tt

y ima

ge

s

In 2009, for example, the German governmentamended its rules so that inspections of emissionsperformance would be based solely on readingsfrom a car’s own “onboard diagnostic” system, ef-fectively ceding total control to the automakers.

At VW, at least, regulators wield less power thanunions. By law, labor receives board representa-tion at all but the smallest German companies.Time and again the Works Council, or Betriebsrat,which holds eight of VW’s 20 board seats, hasplayed a decisive role, mobilizing the support ofthe state government to get its way over the inter-ests of private shareholders.

“VICTORY IS FUN … BUT I CAN’T CELEBRATE”one man, at least, was able to impose himselfon this formidable and politicized structure: Fer-dinand Piëch, a brilliant engineer and a ruthless,terrifying manager who dominated VW for morethan two decades. Chief executive from 1993 to2002, and chairman from 2002 till early last year,Piëch, now 78, infused VW with an ambition anddrive that made the most of its political heft, pre-siding over a culture that was, if not above the

Schröder, who was Chancellor before Merkel, and Sigmar Ga-briel, who is currently her vice chancellor, have both served asVW directors in their function as governors of Lower Saxony.

The nexus between the company and the government thatis supposed to regulate it could hardly be tighter. TraditionallyLower Saxony has used its powers to encourage creating andmaintaining jobs within the state. More than 110,000 of VW’sworldwide labor force of 589,000 work at its immense head-quarters in Wolfsburg and four other plants in Lower Saxony.

That employee base has helped give VW massive clout. Timeand again the German auto industry—the largest in the coun-try—has been able to brandish the threat of job losses if legisla-tion contrary to its interests is passed. The result: a patchworkof regulation watered down to the point of meaninglessness.

Exposed From top: A CARB spokesman describes the lab-testingprocess; the “real-world” apparatus that revealed VW’s deception;Greenpeace activists demonstrate at a company plant in Wolfsburg.


The gap between rulesand realityNOx emissions have been dropping in Europe.But the difference between the legal limits (darkshading)—which auto companies comply with intheir lab tests—and the actual on-road emissions(light shading) has persisted.

0

0.2

0.4

0.6

0.8

1.0 gram/kilometer

EURO EMISSIONSLIMIT

ACTUAL MEASUREDEMISSIONS OF NOx

0.0

0.2

0.4

0.6

0.8

1.0 gram/kilometer

TARGET FOR EUROEMISSION LIMIT

2000 2005 2009 2014

0.6

0.08

SOURCE: EUROPEAN ENVIRONMENT AGENCY

ca

rb

la

b: n

ick

ut—

ap;

em

issi

on

te

st:

we

st v

irg

inia

un

ive

rsi

ty

ce

nt

er

fo

r a

lte

rn

at

ive

fue

ls,

en

gin

es

an

d e

mis

sio

ns;

pr

ot

est

:pe

te

r s

te

ffe

n—

afp

/ge

tt

y im

ag

es



When Piëch resurfaced in 1972 at Audi, by then owned byVW, he dragged it upmarket almost single-handedly with aseries of engineering innovations, such as the four-wheeldrive system for the Quattro. Under Piëch, Audi was also thefirst to enjoy commercial success with a technology called “di-rect injection” in diesel cars. Later generations of the technol-ogy would become an industry standard, including for VW’sClean Diesels.

“I WILL REPLACE ALL OF YOU”it was at audi that Piëch developed his reputation for utterruthlessness with subordinates. “I consciously allow those in

law, then not above stretching it, bymany accounts.

In large measure VW owes itsscale and its culture to Piëch—whowas more or less born into Volkswa-gen. He is the grandson of FerdinandPorsche, who built cars for the Aus-tro-Hungarian imperial family be-fore World War I, long before Hitlertapped him to build the People’s Car.After World War II, Piëch’s uncleFerry Porsche led a de facto researchand development center for VW, anarrangement that provided incometo build the sports cars for whichPorsche is now famous. MeanwhilePiëch’s formidable mother, Louise,created an import, sales, and servic-ing network that became Europe’slargest car distributor.

The quest for colossal achieve-ment and a contempt for anythingthat gets in the way or falls short runlike parallel threads through Piëch’slife. In his own account, Auto. Biog-raphie, he comes across like the de-monic oil prospector Daniel Plain-view in There Will Be Blood whenhe writes, “The struggle for victory isfun, but I can’t celebrate somethingonce it’s been won.”

Overcoming dyslexia, Piëch be-came an engineer and joined Porschein 1963. He squabbled constantlywith his cousins, not least when herisked the company’s future by overspending to com-plete the 917 (which became Porsche’s most success-ful race car). Years of infighting drove the family toremove its members from company management.Piëch didn’t improve relations with the Porscheswhen he later had two children with the wife of hiscousin Gerhard, adding to the five he had had by hisown first wife; five more with two other women fol-lowed. The family hostilities would reach an apexdecades later, when Porsche tried to acquire VW,and Piëch outmaneuvered his cousins and ended upswallowing Porsche instead.

win

te

rk

or

n: m

ar

ijan

mu

ra

t—e

pa/c

or

bis


ing, away from the Detroit giant, seeing a kindredspirit in the Basque who had bullied auto suppliersinto lowering their prices. The move backfired di-sastrously. VW ultimately paid $100 million to set-tle civil claims of corporate espionage and pledgedto buy $1 billion in parts from GM.

Piëch boasted of his willingness to threatenemployees into giving him what he demanded.Bob Lutz, a veteran of GM, Ford, and Chrysler,recalled in a first-person article for Road & Tracklast November how Piëch told him the secret ofthe fourth-generation Golf ’s remarkably tightbody fits: “I’ll give you the recipe. I called all thebody engineers, stamping people, manufacturing,and executives into my conference room. And Isaid, ‘I am tired of all these lousy body fits. Youhave six weeks to achieve world-class body fits. Ihave all your names. If we do not have good bodyfits in six weeks, I will replace all of you. Thankyou for your time today.’ ”

Even then, the reality wasn’t good enough. “Thephotos were still touched up to make the fits looktighter,” says Bertel Schmitt, who wrote advertis-ing copy for VW at the time.

whom I’ve lost trust to starve by the wayside,” he once told DerSpiegel. It was only a slight exaggeration. In the nine years hewas CEO of the Volkswagen group, he ousted three Audi CEOs.The one who finally lived up to his expectations was the manwho would eventually follow him at VW, Martin Winterkorn.

Piëch took the helm of the entire company, VolkswagenGroup, in 1993, when it was nearly bankrupt. He exploitedthat crisis to present himself to skeptical unions and politi-cians as the only one radical enough to turn the companyaround. Then he browbeat the Betriebsrat into accepting afour-day week, with a pro rata pay cut. That same year he hiredJosé Ignacio López de Arriortúa, then GM’s head of purchas-

VW’s powersClockwise from left:Ex-CEO Martin Win-terkorn checks a car’sundercarriage; Chan-cellor Merkel withMatthias Müller, whohas since become VWCEO, and Winterkorn;Ferdinand Piëch, theman most respon-sible for the modernVolkswagen.

me

rk

el:

od

d a

nd

er

sen

—a

fp/g

et

ty

ima

ge

s; p

iec

h:

nig

el

tr

eb

lin

—a

fp/g

et

ty

ima

ge

s


things to worry about such grubby little matters. From the wit-ness stand, he mocked a lawyer who stumbled over his notesas he cross-examined Piëch. “Those who buy Lamborghinis canpronounce it however they want,” said Piëch. “Everyone elseshould pronounce it properly.”

Volkert, after his conviction, tried to pin the blame on thechairman. “Anyone who knows how things are in the companyfinds it hard to imagine that all that happened without Piëch,”he told the press. “There was little he didn’t know about.” Piëchhas always asserted his innocence and never faced prosecution.He didn’t respond to questions emailed by Fortune.

VOLKSWAGEN’S SALVATION: CLEAN DIESEL?it’s against this background, seething with political andfamily rivalries, that VW made its ill-fated 2005 move to crackopen the U.S. market with “Clean Diesel,” the Next Big Thing.At that point Piëch’s turnaround had borne fruit. Early movesinto emerging markets such as Brazil and, above all, China,had paid off handsomely. Revenues and profits had taken off.

But the U.S. remained a long-running disaster. VW hadnearly 19% market share in Western Europe in 2005. In theU.S. it had a scant 2%. The days when Herbie the Love Bug andcamper vans filled with hippies and surfers had captured thepublic’s imagination were long gone. Between 1988, when VWabandoned a 10-year experiment making a U.S. version of theGolf at an old Chrysler factory in Pennsylvania, and 2011, whenit opened a new plant in Chattanooga, the company didn’t makea single car in the U.S. That put it at a big disadvantage not justto Detroit, but to Japanese rivals who had set up stateside.

Clean Diesel would change all that, contended BerndPischetsrieder, whom Piëch had plucked from BMW to suc-ceed him as CEO. U.S. gas prices were then soaring toward$3 a gallon, and climate change was looking like an ever moredire threat. Pischetsrieder concluded that if VW could combineperformance, modest price, and environmental appeal, it could

In 2004, after Piëch had moved from the CEO’sseat to chair the supervisory board, the VW systemgenerated another scandal that dwarfed the Lópezaffair. It emerged that the company had, for nearly10 years (beginning less than two years into Piëch’sreign and soon after the deeply unpopular cuts tohours and wages), been showering high-ranking la-bor representatives with, among other things, pros-titutes for Betriebsrat members and all-expense-paid luxury shopping trips to Paris for their wives.Betriebsrat head Klaus Volkert was treated espe-cially kindly, getting 2 million euros in bonuses over10 years, while his Brazilian mistress was subsidizedto the tune of 400,000 euros. Both Volkert and aVW executive were convicted of criminal abuse ofoffice as a result. Piëch personally signed off on abig, unscheduled increase to Volkert’s pension.

The center-left Social Democratic Party cameoff particularly badly in the scandal, with seniorofficials exposed as feasting at the trough. PeterHartz, VW’s chief of personnel and the architectof Chancellor Schröder’s radical labor reforms,pleaded guilty to criminal charges. It emerged thatsome sitting SPD lawmakers were drawing salariesof over 5,000 euros a month from Volkswagen, al-legedly for nothing in return. (Two lawmakerswere convicted of receiving illegal payments.)

The dirt flew in all directions, but none stuck toPiëch. Summoned to testify in 2008, he presentedhimself as a maligned titan too busy with higher

NOx-ious DieselsThese models, all with TDI technology, wereamong the 15 with cheating software. Their valueis diminished, and VW must now fix—or buy—the580,000 sold in the U.S. (Another 10.5 million,including other models, were sold elsewhere.)

VW Jetta2009–15

VW Touareg2009–16 VW Golf

2010–15

VW Passat2012–15

VW Beetle2013–15

ca

rs: c

ou

rt

esy o

f vw

, au

di, a

nd

por

sch

e


had received numerous reports in 1999 and 2000about a defective exhaust part, which was causingexcess carbon monoxide and other dangerous emis-sions, but failed to report the defect to regulators,as required, until the EPA came across it in a ran-dom test. Only then had VW instituted a recall—of329,000 cars—at a cost of $26 million. VW did notadmit wrongdoing, but it did sign a consent decreepromising to “enhance its system for monitoringand reporting emission-related defects.”

Adding to VW’s challenge, the U.S. had an-nounced even stricter rules for 2009. These per-mitted maximum emissions of 44 milligrams ofNOx per kilometer, about one-fourth the 180 mg/km permitted by the Euro 5 standard that wouldalso take effect in 2009. (Even the Euro 6 standard,which took effect in 2014, permits 80 mg of NOxper kilometer—still nearly twice the U.S. limit.)

Diesel trucks have long used a costly and bulkyNOx-suppression method known as selectivecatalytic reduction. SCR involves squirting anammonia-infused fluid, urea, into the exhaust, whichconverts the NOx into nitrogen, CO2, and water.

By 2006, as the VW engineers pursued their task,rival DaimlerChrysler was already marketing cleandiesel cars that used an SCR system. VW licensedthe technology—but then chose not to use it, pos-sibly because of changes at the top.

In November 2006, CEO Pischetsrieder wasforced out by chairman Piëch, under pressure fromthe Betriebsrat. (The CEO had tried to lengthen thework without full compensation and lost the ensu-ing battle.) The new chief was Winterkorn, a Piëchfavorite, whom he had hired at Audi 25 years earlier.

Even as Piëch maneuvered, there’s a sign thatVW engineers were considering the use of soft-ware that would let the company cheat on itsemissions testing, according to a recent articlein the Süddeutsche Zeitung, which attributed theinformation to a preliminary report from VW’sinternal investigation. At that point in November2006, it appears, it was simply talk; no evidencehas emerged that Piëch knew about it.

By August 2007 the deal to use Daimler’s tech-nology had been scrapped. It’s unclear preciselywhy, though some accounts have posited vanity:Volkswagen wanted its own system.

restore its rightful place in the world’s biggest auto market.But the U.S. presented daunting regulatory obstacles.

American environmental protection has always focused onpollution, particularly Southern California smog—precise-ly what the NOx emissions from diesels exacerbate. Thatstate’s powerful regulator, the California Air Resources Board(CARB), given extraordinary powers under the federal CleanAir Act, led the U.S. to adopt stringent NOx restrictions.

Europe had taken a different approach. Diesel was no-ticeably cheaper and more plentiful than gasoline, a crucialadvantage in a region lacking in oil. Having signed the 1997Kyoto Protocol, European governments were also more fo-cused on climate change and the reduction of greenhousegases, especially CO2. Good fuel economy—the diesel engine’slong suit—reduces CO2 emissions. EU states started to taxvehicles according to their CO2 output. And they placed lessimportance on NOx and carcinogenic soot, which diesels pro-duce in higher quantities than gas engines.

“A range of policy choices skewed the market in favor ofdiesel, whereas in the rest of the world this didn’t happen,”says Greg Archer, who heads the Clean Vehicles arm of Trans-port & Environment, a nongovernmental organization basedin Brussels. At the start of the 1990s diesels accounted forabout 10% of the light-vehicle fleet in Europe. By 2014, 50%of all new vehicles licensed in the EU were diesels.

“NO ONE HAD THE COURAGE TO ADMIT FAILURE”the job of executing on Pischetsrieder’s vision of a hit U.S.diesel car fell to a group of engineers in Wolfsburg. Their keychallenge was designing an engine that could satisfy America’sstringent NOx regulations without sacrificing performance orfuel economy, while remaining competitive in sticker price.

This was occurring just after VW received what amountedto a public warning about its emissions. In 2005 the companyagreed to pay a $1.1 million fine after the EPA alleged that VW

Porsche Cayenne2013–16 Audi Q7

2009–15

Audi A82014–16


to auto shows as it planned to display because Winterkornwas known for vetoing a particular selection if he detected theslightest imperfection.

Like his mentor, Winterkorn had outsize ambitions. Oneof his first acts as CEO was to unveil a plan to overtake bothGeneral Motors and Toyota by 2018 to become the world’sNo. 1 automaker, “not just in units, but in profitability, inno-vation, customer satisfaction, everything,” as he put it. Win-terkorn wanted everything.

His approach seemed to work. VW grew rapidly during histenure, surpassing Ford as No. 3 in global sales in 2008 andleapfrogging General Motors into second place in 2014. In thefirst half of last year, VW briefly edged Toyota for the top spot.Between 2007 and 2014, Winterkorn more than doubled thegroup’s operating profits and dividends. Revenues hit 200 bil-lion euros for the first time in 2014. Still, VW would find it hardto reach the global pinnacle without significant sales of dieselsin the U.S.

THE CHEATING DEEPENSas the first decade of the 21st century ended, VW was en-joying accolades and healthy sales for its green diesels. Butthere were hints that the German auto industry, if not VW inparticular, was uncomfortable with the U.S. emissions rules.

Merkel herself weighed in on the issue in April 2010. TheChancellor met that month with California Gov. Arnold Schwar-zenegger and CARB chief Mary Nichols at the Four Seasons inBeverly Hills, according to comments that Nichols made to thepublication Handelsblatt (which were confirmed to Fortune bya CARB spokesperson).

As soon as Schwarzenegger left the meeting, it seems, Merkelpounced on Nichols and said, “The strict nitrogen oxide limitsin California are damaging German carmakers,” Nichols toldthe publication. “I never experienced a similar interventionagainst our environmental laws by a politician either beforeor after.” The lobbying yielded nothing. (A spokesperson forMerkel did not respond to requests for comment.)

Meanwhile there are hints that by 2011, word of VW’scheating was circulating to higher levels. A whistleblowerallegedly revealed the use of a defeat device to Heinz-JakobNeusser, a Volkswagen brand-development boss and, later,management board member, according to the SüddeutscheZeitung. (Neusser, who didn’t respond to a request for com-ment, was suspended after the scandal erupted.)

Roughly three years had passed since VW had begun itsdeception. The engineers viewed the ruse as a stopgap mea-sure, Volkswagen has suggested, and hoped to abandon itwhen better technologies became available. Now, in 2011,

The pressure seemed to intensify inside VW.It wasn’t “acceptable to admit anything is impos-sible,” a company whistleblower told Jones Day,according to the Süddeutsche Zeitung. “Instead oftelling management that they couldn’t meet theparameters, the decision was taken to manipulate.No one had the courage to admit failure. More-over, the engine developers felt secure becausethere was no way of detecting the deceit with thetesting technology that existed at the time.” It was,the whistleblower said, “an act of desperation.”

A fateful decision had been made. But that’s notwhat was presented to the outside world. In spring2008, VW announced the solution to its U.S. woes:a new engine that used a variation on the direct in-jection that Audi had used under Piëch years beforeand many had used since. VW billed it as a “next-generation turbo diesel developed especially for theNorth American market.”

But the biggest selling point was that this high-performance diesel was clean. This engine had adifferent technology than VW had previously usedto reduce emissions, a solution called the lean NOxtrap. The technical details don’t really matter. Thebottom line is that the engineers couldn’t get it towork, at least not without unacceptable consequenc-es for fuel economy or drivability.

No matter. The 2009 VW Jetta diesel, equippedwith the lean NOx trap and defeat-device soft-ware, launched in April 2008 and would soon befollowed by similarly equipped VW Golfs and AudiA3s. More than 145,000 of the vehicles would besold over the next three years.

A MICROMANAGER WITH TITANIC AMBITIONSby this time, Piëch had already been out of theday-to-day running of the business for six years.He and the CEO were presented as the DreamTeam: Piëch was the visionary patriarch, Winter-korn the perfectionist master of detail. Winter-korn might have been a notch less imperious thanthe chairman, but he still displayed an almost the-atrical officiousness: He publicly dressed down hisjuniors at an auto salon for failing to build a steer-ing column that could be adjusted as smoothly as aHyundai’s. He was known for carrying a microm-eter to check the minutest measurements of cars.VW routinely transported twice as many vehicles




sis dynamometers, or dynos, where the car is locked into place while itswheels spin on rollers. The artificial environment lets scientists controlvariables, like ambient temperature and wind, and ensure that all ve-hicles are subjected to an identical simulated-driving sequence.

Unfortunately that approach makes it possible to cheat. Software inthe car’s engine control unit can detect when the vehicle is being sub-jected to the unique series of routines that characterize a test. It can,therefore, instruct emissions-control equipment to kick in during a testbut switch off under real-world driving conditions.

It is also possible to test emissions during real-world driving, usinga portable emissions measurement system, though the process is cum-bersome. In 2011, after government researchers conducted a series ofthose tests, the European Commission found that diesel cars were spew-ing as much as seven times more NOx on actual roads than they were inthe lab. Other experiments—for both gasoline and diesel cars—revealedsimilar results. (The discrepancies have been increasing. In 2001, Eu-ropean cars of all sorts were getting 7% fewer miles per gallon on theroad than they demonstrated on the dynamometer. By 2014 the gap hadwidened to 40%.)

These results did not necessarily mean that carmakers were usingillegal defeat devices. The in-lab test regimen used in Europe wasquite old—test cars were never equipped with air conditioning, for in-stance—and it was possible that the mix of driving situations simulatedduring the test simply no longer reflected modern-day reality.

Still, engineers at the nonprofit International Council on Clean Trans-portation suspected that at least some of the disparity might reflect car-makers’ gaming the system and exploiting lax European compliance andenforcement mechanisms. In Europe, for instance—unlike in the U.S.—countries do not spot-check emission levels, and failings, when detected,are not punished as severely. In addition a car model certified as compliantin one EU country must be accepted as compliant in all others—a situationthat can lead to shopping for the most lenient testing service.

In collaboration with CARB, the ICCT contracted with a group of engi-neers at West Virginia University to compare the NOx emissions of threeU.S. diesel cars in and out of the lab. The researchers’ hypothesis wasthat any discrepancy would be far less than what European researcherswere finding because of the more robust U.S. regulatory regimen. Armed

instead of stopping or slowing down,the company intensified the misbehav-ior. Volkswagen introduced a new gen-eration of exhaust configuration, whichused the more tried-and-true SCR sys-tem, in some models.

But even the new configuration em-ployed defeat devices, VW has admit-ted. The engineers did this, Volkswagenchairman Hans Dieter Pötsch acknowl-edged in a presentation to sharehold-ers in December, to overcome a majorinconvenience associated with SCR.The technology necessitates a tank tocarry all the urea that must be squirtedinto the exhaust. But unless that tank isimpractically enormous, the fluid mustbe replaced frequently by a licensedservice station, which would annoy theconsumer. VW wanted each tank ofurea to last at least 16,000 kilometers,so it could be replaced when the ownercame in for a routine servicing and oilchange. By installing a defeat device,the urea was conserved sufficientlyto meet this goal—although it meantbelching illegally high levels of NOx.

Almost 90,000 of these Passat die-sels, from the 2012 to 2014 model years,were sold. During that same period VWsold another 180,000 Golfs, Jettas,Audi A3s, and, beginning in 2012, Bee-tles, all still equipped with the fraudu-lent LNT system.

By model year 2015 the company wasable to introduce a third generation ofits Clean Diesel car. All would now comewith the superior SCR system—but allstill came with defeat software too. Volks-wagen sold about 33,000 third-genera-tion vehicles though September 2015.

DOUBTING THEIR GAUGEShistorically, regulators in Europeand the U.S. have relied on highlycontrolled lab tests when monitor-ing pollutants like NOx. The tests areperformed on platforms called chas-

“We got a lot of pushback. [VW] saidour testing was inaccurate, that wehadn’t taken into consideration avariety of circumstances.”


with such results, the ICCT hoped topersuade the European Commission tobeef up its own policing.

Due mainly to happenstance—whichmodels proved easiest to rent or bor-row—the researchers ended up with aBMW X5 and two VWs, a Jetta and aPassat, as test vehicles. In the research-ers’ test drives, the BMW appeared toconfirm ICCT’s hypothesis: Its emis-sions were as good on the road as onthe dyno, staying within the NOx limits.

When they tested the VWs, however,the results were perplexing. “We wereseeing a disparity,” says Greg Thomp-son, the principal investigator. At firstthey doubted their gauges, he says,but when the data persisted, “we knewthere was something causing a dual op-eration.” The Jetta was belching 15 to35 times the permissible levels of NOx,while the Passat was emitting five to 20times the maximum.

That didn’t prove VW was using adefeat device. “We then had just twodata points,” Thompson stresses—twovehicles from a fleet of thousands.“There could’ve been reasonable ex-planations.” Maybe something was justmalfunctioning.

The key findings of the West Virginiagroup—already known to CARB and theEPA—were revealed for the first timeon March 31, 2014, at a conference inSan Diego on emissions testing. Thoughthe researchers identified the test carsonly as Vehicles A, B, and C, the makeswould have been easy to guess for autoengineers. In the U.S., VW was the onlymanufacturer selling a passenger dieselwith a lean NOx trap, or 2.0 liter dieselswith an SCR system.

THE UNRAVELINGon april 7, ICCT engineer FranciscoPosada says, he got an email from aVW of America official seeking to verifywhich cars were VWs. The news appears

Acceleratingtime to value

Hewlett Packard Enterprise, the number 1 companyin cloud infrastructure, is accelerating business outcomes

for companies around the world.

hpe.com/value

© Copyright 2016 Hewlett Packard Enterprise Development LP.Source: Synergy Research. Q3 2015 Data, Combined Cloud InfrastructureEquipment, Software and Services revenue data.


Is fixing the U.S.cars possible? VW has started recallsin Europe to make itsdiesels comply withemissions rules, butit can’t do that in theU.S. until regula-tors approve a plan.They rebuffed VW’sfirst try, and somepeople doubt repairsare even possible formost of the cars. VWmay need to buy backthose vehicles.

How high up doesresponsibility go?The results of VW’sinternal probe areexpected in June,while discovery in theconsolidated classactions is supposedto finish by December.The extent of VW’sexposure to punitivedamages—which willaffect the size of anysettlement—will hingeon whether, and when,top executives knew ofwrongdoing.

Will criminalprosecutions occur?Prosecutors in theU.S. and five othercountries are believedto be probing theevents. “It’s only fairthat the people whoare responsible forcommitting [corpo-rate] crimes be heldaccountable,” a topJustice Departmentofficial announcednine days before thescandal surfaced.

How big will civilpenalties be?Federal law theoreti-cally authorizes about$45 billion in fines forthe environmentalviolations the EPA hasalleged. State lawscollectively authorizea nearly equal sum.Though no one expectssuch draconian sanc-tions, more realisticnumbers are impos-sible to estimate untilmore is known aboutthe facts.

Mitigation?For environmentaldamage that can’tbe undone, plain-tiffs lawyers—andregulators—canask for open-endedforms of relief beyondcompensation to carowners. These mightinclude efforts byVolkswagen to cleanup the environmentor a promise to beefup its commitment toelectric cars.


sions issue, wrote CEO Winterkorn a memo about possible repercussionsfrom the report. The company “would not be able to give officials ‘a soundexplanation for the dramatically elevated’ nitrogen oxide emissions,” hismemo warned, according to the New York Times, and regulators were“likely to investigate whether Volkswagen cars were equipped with ‘a so-called defeat device.’ ”

CARB took the lead in questioning Volkswagen about the results anddoing additional testing. Some 10 meetings were held between CARB’s en-gineers and VW’s, says CARB spokesperson Young. (His organization didnot permit its engineers to speak to Fortune because of ongoing litigationand investigations.)

“We got a lot of pushback,” according to Young. “They said our testingwas inaccurate and didn’t take into consideration a variety of circum-stances that occur on the open road, in traffic, load, incline, exceedanceswith engineering limits.” The Justice Department and EPA have sincealleged in their suit that VW officials “impeded and obstructed” CARB’sinquiry by providing “misleading information,” “conceal[ing] facts,” andmaking “affirmative misrepresentations.”

In late 2014, Volkswagen suggested to CARB that since it was alreadyplanning a voluntary recall relating to some hardware durability issuesin the exhaust system, it would make software changes at the same timethat would fix the emissions anomalies. The recall was completed by thespring of 2015.

As that was occurring, turmoil bubbled up yet again inside VW. Thepatriarch, Piëch, made one move too many. When the company’s mo-mentum began to cool, he attempted to oust Winterkorn. This time,though, the protégé outmaneuvered his mentor. Winterkorn alliedhimself with the unions—and Piëch’s own cousins. The board turnedagainst him, and the chairman stepped down in April.

Meanwhile VW’s diesel emissions imbroglio wasn’t going away. After

to have reached Wolfsburg quickly. Bylate April an internal Volkswagen pre-sentation discussed strategies the com-pany could use in response, accordingto a recent New York Times report: “Oneoption was for Volkswagen to offer to up-date the engine software. But the updatewould not bring emissions down to therequired levels, the presentation said.”

The West Virginia University re-searchers’ 117-page report was publishedon May 15, 2014. “We were just thinking,How do we fix this?” says CARB spokes-person Stanley Young. “We were still as-suming it was a technical issue.”

Some people at VW, it appears, sus-pected it wasn’t a technical snafu—andthat information may have reached thetop of the company. According to ac-counts in Bild am Sonntag and otherpublications, in May 2014, Bernd Gott-weis, a former VW official who had comeout of retirement to help with the emis-

5 Questions That WillDetermine VW’s FateHow soon Volkswagen can putthe Clean Diesel mess behind itdepends on these key issues:


the recall CARB tested the vehiclesanew. They flunked again. “There wasa slight reduction in NOx,” says Young,“but it wasn’t significant enough.”

A year had passed since the studyrevealing VW’s odd emissions resultsand since Winterkorn was reportedlywarned of a possible defeat device.The company kept selling diesels—andCARB’s engineers kept testing. Theresults got fishier. “One of the telltalesigns,” says CARB’s Young, “was that thecar was running much cleaner whencold than when it was hot—contrary tostandard automobile engineering.”

Finally came the coup de grace. “Wetweaked the test in the lab to fool thecar into thinking it was no longer in thelab,” says Young, “and that it was out inthe open road. The emissions jumped.”Clearly the car had a defeat device.

CONFESSION AND DENIALin july 2015 the EPA ran out of pa-tience. It issued an ultimatum: Theagency would not certify any of theVW’s 2016 model year 2.0-liter dieselsuntil it received a credible explanationfor what CARB was finding.

In meetings over the next severalweeks, according to CARB, VW engi-neers finally admitted what they haddenied for months—that since 2008 thecompany had installed undisclosed soft-ware in diesel engines that triggered a“second calibration intended to run onlyduring certification testing.” On Sept. 3a Volkswagen official formally signed adocument to that effect. The documentremains confidential, but CARB hasstated that in it “VW admitted … that itdesigned and manufactured its 2.0-literdiesel vehicles with defeat devices to by-pass, defeat, or render inoperative ele-ments of the vehicles’ emission-controlsystem.” (VW declined comment.)

The world learned of the scandal

© Copyright 2016 Hewlett Packard Enterprise Development LP.Source: Fortune Global 2015; HPE Customers 2013 Q3 - 2015 Q2.

hpe.com/protection

Acceleratingprotection

Hewlett Packard Enterprise security products and solutionshelp protect 8 of the top 10 Fortune Global 500 companies.

investigation but then confidently averredthat Winterkorn “had no knowledge of themanipulation of emissions readings.” Theboard also promised to establish “a newmind-set” at the company, with “more ca-pacity for criticism”—seemingly concedingthere was something poisonous about theculture Winterkorn presided over.

So who did the board select to leadthe “unsparing” cleanup it was promis-ing? Two company insiders with long-term ties to Winterkorn. Matthias Müller,Porsche’s chief and a 30-year VW veteran,was named CEO, while CFO Hans Diet-er Pötsch was moved to chairman. SinceSeptember at least 11 top executives, in-cluding two top engineers who oversawdevelopment of the engines in question,have been suspended or have departed.

More than once the company hasshown signs of being in denial. In earlyNovember, when the EPA declared thatVW’s 3.0-liter engines were also usingdefeat devices, the company insisted that“no software has been installed” in those

vehicles “to alter emissions characteristics in a forbidden manner.” But21 days later its Audi division, which made those engines, admitted that,yes, they too incorporated a defeat device.

The scandal’s impact is not abating. Last month VW put off the an-nouncement of its annual results until April and postponed its annualshareholders meeting until June, at which time it is expected to revealthe results of the Jones Day internal probe.

The German KBA, or Federal Vehicle Agency—an arm of the Minis-try of Transport—has already approved the company’s proposed Euro-pean recall in which VW will “fix” most of the millions of affected carsthere with a software update, requiring just 30 minutes to effectuate.The agency has evidently accepted VW’s contention that the switch willhave no appreciable impact on fuel economy or performance—beggingthe question why the offending software was ever put there in the firstplace. (European cars had different emissions-reduction hardware thanU.S. cars, so the software had different impacts, VW has said. It declinedto elaborate, however, for Fortune.)

In the U.S., Judge Breyer is pushing the class action forward on a veryfast track and appointed former FBI director Robert Mueller to ride herdon the parties to settle. “I am deeply concerned about vehicles being onthe road which are polluting,” Breyer said at a hearing, during which herecalled his youth in a California that was choked by smog. “We all ought

about two weeks later, when the EPAissued a formal notice of violation relat-ing to nearly 500,000 2.0-liter dieselcars—stretching across seven modelyears and three generations of exhaust-treatment configuration.

Next, the regulators scrutinized VW’s3.0-liter, six-cylinder diesels—mainlySUVs and luxury cars. Sure enough,these engines contained defeat devicestoo, though they worked a bit differently.

The method shows how finely tunedthe cheating was. A key phase of thestandard U.S. emissions test lasts ex-actly 1,370 seconds. Audi’s software,the regulators discovered, was calibrat-ed to emit a legal amount of emissionsfor precisely 1,370 seconds. Whenthe 1,371st second elapsed the soft-ware switched settings, so that the carspewed up to nine times the permittedamount of NOx, the EPA alleges. How’sthat for German engineering?

On Nov. 2 the EPA issued anothernotice of violation—this one for fivemodels of Audi, the Porsche Cayenne,and the VW Touareg. Their engineswere developed by Audi engineers inIngolstadt, Germany, about 300 milessouth of Volkswagen’s Wolfsburg facility,where the first group of purported bad-apple engineers worked. That meanstwo groups of engineers were allegedlybreaking the law in parallel for sevenyears, with seemingly little in commonexcept the upper-level executives theyanswered to.

AFTERMATH: BAD TO WORSEvw’s response to the exposure of itschicanery was revelatory in its confusion.Within a five-day period, CEO Winter-korn publicly apologized on behalf of thecompany, disavowed any personal knowl-edge of wrongdoing, vowed to stay on asCEO—and then resigned. The board, forits part, pledged a full and independent



Within fivedays of therevelations,VW’s CEOapologized,disavowedknowledgeof wrong-doing, vowedto stay on—and thenresigned.

to move as quickly as possible to resolvethis in a sensible way.” In February thejudge, fed up with waiting, slapped VWwith the March 24 deadline to proposespecific “fixes”—or be prepared to startbuying vehicles back.

Both sides have committed to com-plete the discovery process by the endof 2016—lightning-quick by U.S. stan-dards. But it seems increasingly unlikelythat any fix for the lean NOx trap ve-hicles—roughly 60% of the diesels in-volved—will ever be approved by regula-tors. A buyback may be needed for those.

Plaintiffs lawyers—and regulatorstoo—will also be pressuring VW forsteps known as “mitigation” to make upfor the damage to the environment thatcan’t be undone. These might includecommitments by Volkswagen to ex-pand its efforts in the arena of electriccars. Indeed, CEO Müller has alreadypromised a range of at least 20 hybridor electric vehicles by 2020.

In Europe, meanwhile, German car-makers continue to fight emissionsregulations. The European Union hasmoved forward with plans, already ontrack before the scandal, to mandate on-the-road testing in 2017, supplementingthe all-too-easy-to-fool lab testing. ButMerkel reportedly pressed the EU to re-lax the new standards, apparently aftershe was lobbied by the German AutoIndustry Association. Sure enough, thenew European rules will permit dieselcars to produce more than double theNOx on the road than they’re permittedon the dyno until 2020, and even afterthat, 1.6 times more.

Back stateside, it’s a much differ-ent picture. Judge Breyer doesn’t give adamn what Merkel or the European autoindustry think. Here, VW is defenselessand grievously exposed. It’s stuck oncruise control, hurtling toward a devas-tating reckoning.


Acceleratinganalysis

10 of the Forbes 10 World’s Most Valuable Brandsgain insights and create value with

Hewlett Packard Enterprise big data solutions.

hpe.com/analysis

© Copyright 2016 Hewlett Packard Enterprise Development LP. Source:Forbes Most Valuable Brands 2015; HPE Customers 2013 Q3 - 2015 Q2.

Documents

How the massive diesel fraud incinerated VW s reputation ... · How the massive diesel fraud incinerated VW s reputation and will hobble the company for years to come. PHOTO ILLUSTRATION