Volkswagen’s Dieselgate

On Sept. 18, 2015, the U.S. Environmental Protection Agency (EPA) issued a notice of violation of the Clean Air Act to German automaker Volkswagen Group. The EPA contended that Volkswagen had intentionally programmed diesel engines to activate certain emissions controls only during laboratory emissions testing. The programming changed the vehicles’ nitrogen oxide (NOx) output to meet U.S. standards during regulatory testing but released up to 40 times more NOx in real-world driving. Volkswagen installed this programming in approximately 11 million cars worldwide and in 500,000 cars in the U.S. from 2009 through 2015. (See Volkswagen Says 11 Million Cars Worldwide Are Affected in Diesel Deception, by Jack Ewing , The New York Times, Sept. 22, 2015.)

Volkswagen immediately became the target of regulatory investigations in more than a dozen countries, and Volkswagen’s stock price fell in value by a third shortly after the news broke. Within days, the powerful Volkswagen Group CEO Martin Winterkorn resigned, and the company suspended three senior managers. Volkswagen then announced plans to spend $7.3 billion on rectifying the emissions issues and planned to refit the affected vehicles as part of a recall campaign. The scandal raised awareness over potential cheating at a variety of car manufacturers. (See Volkswagen CEO Resigns as Car Maker Races to Stem Emissions Scandal, by William Boston, The Wall Street Journal, Sept. 23, 2015.)

On April 21, 2016, the U.S. District Court for the Northern District of California (which the U.S. Department of Justice appointed in December 2015 to oversee almost all U.S. litigation, including all claims filed by vehicle owners and state governments) announced that Volkswagen will offer its U.S. customers “substantial compensation” and car buyback offers for nearly 500,000 vehicles, as part of a settlement aiming to resolve the emissions scandal in North America, according to Volkswagen Reaches Deal in U.S. Over Emissions Scandal, by Jack Ewing, The New York Times, April 21, 2016.

On Oct. 25, 2016, the federal courts approved a $14.7 billion dollar settlement for 475,000 owners of Volkswagen and Audi 2.0 liter engines. On top of this, Volkswagen has agreed to provide $5 billion to environmental programs, reduce emissions and promote zero-emission vehicles. (See The biggest auto-scandal settlement in U.S. history was just approved. VW buybacks start soon, by James F. Peltz and Samantha Masunaga, Oct. 25, 2016, LA Times.)

However, this isn’t the end of the story. Volkswagen is still in the process of settling with owners of the 3.0 liter diesel engine, which could cost the company at least another $1 billion. (See Volkswagen Expected to Pay Another $1 Billion in Emissions Scandal, by Hiroko Tabuchi, Dec. 20, 2016, The New York Times.)

Apart from the legal and compliance issues facing Volkswagen, the company continues to lose market share both in the U.S. and its home European markets. (See VW Extends European Market Share Losses After Diesel Scandal, by Ania Nussbaum, Sept. 15, 2016, Bloomberg.)

According to The New York Times, Volkswagen is expected to plead guilty to criminal charges of conspiracy to commit wire fraud and to violate the Clean Air Act, customs violations and obstruction of justice. The company is also expected to agree to pay a record $4.3 billion in fines in a deal that would resolve the federal criminal investigation into its cheating. This expected guilty plea and the recent arrest of a Volkswagen executive in Miami on conspiracy charges bucks a pattern of companies essentially paying their way out of criminal accusations.

Heading down the path of no return

Volkswagen insiders who’ve had years of experience working with the company told me that management considered the entire emissions cheating scandal as little more than a kind of “tax optimization.” In other words, management saw the cheating as a bending of the rules but nothing terribly bad. I found this hard to believe. So I did further research and found a lot of information to support that statement.

During an interview with NPR radio on Jan. 10, 2016, at the North American Auto show in Detroit, Matthias Mueller, the newly appointed CEO responded in this manner:

NPR: You said this was a technical problem, but the American people feel this is not a technical problem, this is an ethical problem that’s deep inside the company. How do you change that perception in the U.S.?

Matthias Mueller: Frankly spoken, it was a technical problem. We made a default, we had a ... not the right interpretation of the American law. And we had some targets for our technical engineers, and they solved this problem and reached targets with some software solutions which haven’t been compatible to the American law. That is the thing. And the other question you mentioned — it was an ethical problem? I cannot understand why you say that.

(See  ‘We Didn’t Lie,’ Volkswagen CEO Says of Emissions Scandal, by Sonari Glinton, Jan. 11, 2016, NPR.)

Apparently, Volkswagen has a different definition of “ethics” in its management handbook.

To be fair, after the conversation aired on NPR stations, Mueller asked for a “do-over.” The company apparently realized the seriousness of its problems. So NPR recorded another conversation. Here’s part of it:

Mueller: I have to apologize for yesterday evening because the situation was a little bit difficult for me to handle in front of all these colleagues of yours and everybody shouting. OK. Thank you very much for coming again and giving me the opportunity to say some words.

NPR: When we talked yesterday, the key line seemed to be that this was a technical error. Which sounds to us in English, like, “Oops.” When it wasn’t an oops. It was more than a technical error. It seemed to be intentional.

Mueller: Yeah, the situation is, first of all we fully accept the violation. There is no doubt about it. Second, we have to apologize on behalf of Volkswagen for that situation we have created in front of customers, in front of dealers and, of course, to the authorities. ...

Applying the Fraud Triangle

As fraud examiners, we know that people commit fraud — not systems, computers or anything else. It’s a choice — a decision that we often analyze through the lens of Cressey’s Fraud Triangle.

Based on reports and available quotes, here’s how I believe VW’s Dieselgate fits into the Fraud Triangle.

Pressure: Volkswagen was fighting neck and neck with Toyota to become the world’s largest automobile producer. Gaining market share in the U.S. was key to its strategy of becoming No. 1. (Interestingly, the desire to be No. 1 versus being No. 2 is purely egocentric.)

To gain foothold in the market, Volkswagen wanted to rely on the success of its European diesel engine cars. However, to make this happen, the engines would need to meet the much stricter U.S. emissions standards. However, the company didn’t have a plan B. VW management (CEO Winterkorn, in particular) took off the table the alternative of using technology licensed from Daimler-Benz. Therefore, Volkswagen gave a small group of VW engine specialists the assignment of making it work. Failure wasn’t an option. Therefore, real pressure came straight from the top.

Opportunity: At the heart of cars are multiple complex computer processors that are constantly monitoring and controlling the various systems, including emissions. Volkswagen engineers rewrote proprietary software code — its “defeat device” — to try to trick regulators and pass the emission requirements. This was the opportunity to commit fraud.

Rationalization: We already know that Volkswagen desperately needed to become the No. 1 auto manufacturer in the world. Germans feel very patriotic about one of the country’s largest employers.

Volkswagen considered cheating on emissions testing as merely bending the rules for the greater good of the organization. It believed that the American emissions standards were much too stringent as compared to those in Europe and elsewhere in the world and therefore didn’t consider cheating a big deal. Also, it appears that it had knowledge that other automobile manufacturers were also bending the rules and cheating on similar tests.

The question many have been asking is how the organization could possibly condone, and even promote, the idea of a defeat device when it knew the potential financial risk to the organization. Again, perhaps we need to look at the culture of the organization and the overall pressures and rationalizations to understand the decision-making process.

What were the red flags at Volkswagen that could’ve been signals to CFEs that the company was prone to unethical or even fraudulent behaviors?

• Authoritarian style with “yes men.”
• Unreasonable pressures placed on employees.
• Lack of transparency in decision-making/approvals.
• Rationalization that the “good of the company” trumped everything else.
• Inability for those who wanted to speak up without fear of retaliation.

Lessons learned

Is it difficult to create ethical cultures? Yes, it’s a huge challenge for any organization. However, it should be a goal worth achieving. If you’re serious about ethical behavior, then make it your No. 1 priority. Not in the top 10. Not even No. 2 or 3.

Make your success, and that of your organization, dependent on reaching a level of ethical decision-making that makes you proud to be associated with your organization and reflects the basic moral values that we as human beings strive to achieve. Once you do that, the program comes as second nature and will become an inseparable part of the organization’s DNA.

CFEs’ roles are to make organizations aware of the available tools and techniques for gathering and measuring ethical temperatures and to help them to proactively confront problem areas before potential life-threatening crises.

Steve C. Morang, CFE, CIA, CRMA, is a senior manager at a CPA firm and president of the ACFE’s San Francisco Chapter. His email address is: steve.morang@yahoo.com.