Diesel Issue

IRREGULARITIES IN EMISSIONS

On September 18, 2015, the U.S. Environmental Protection Agency (EPA) publicly announced in a “Notice of Violation” that irregularities in relation to nitrogen oxide (NO_x) emissions had been discovered in emissions tests on certain vehicles with Volkswagen Group diesel engines. Volkswagen admitted to irregularities in this context. In its ad hoc release dated September 22, 2015, the Volkswagen Group announced that noticeable discrepancies between the figures achieved in testing and in actual road use had been identified in around eleven million vehicles worldwide with certain diesel engines.

On November 2, 2015, the EPA issued another “Notice of Violation” alleging that irregularities had also been discovered in the software installed in vehicles with type V6 3.0 l TDI diesel engines. Audi has confirmed that at least three auxiliary emission control devices (AECDs) were not disclosed in the course of the US approval documentation of vehicles with six-cylinder V6 3.0 l TDI diesel engines.

EXTENSIVE INVESTIGATIONS BY VOLKSWAGEN

Volkswagen is working intensively to clarify the issue. To this end, Volkswagen ordered both internal inquiries and external investigations. The external investigation is being conducted with the involvement of external lawyers in Germany and the USA. To facilitate the investigations in the course of clarifying the facts, the Group Board of Management established a cooperation program in 2015, which was in place for a limited time and was open to all employees covered by collective agreements.

The Supervisory Board of Volkswagen AG formed a special committee that coordinates all activities relating to the diesel issue for the Supervisory Board. Further information regarding the special committee on diesel engines can be found in the Report of the Supervisory Board. Volkswagen AG commissioned an external investigation by US law firm Jones Day. This is an independent and comprehensive investigation to address the diesel issue. Jones Day is updating the Company and the Department of Justice (DOJ) on the current results of its investigation on an ongoing basis and supports Volkswagen AG in its cooperation with the judicial authorities. The course of action in clearing up the situation was determined largely by the investigative authorities.

Furthermore, Volkswagen AG filed a criminal complaint in September 2015 with the responsible public prosecutor’s office in Braunschweig, which is independently investigating the matter, including allegations of fraud. Searches were carried out in Wolfsburg and elsewhere with the involvement of special agents from the State Office of Criminal Investigation.

We are cooperating with all the responsible authorities to clarify these matters completely and transparently.

Investigations were divided into two parts. The Group Internal Audit function, which involved bringing together experts from various Group companies to form a task force, focused – as instructed by the Supervisory Board and Board of Management – on reviewing relevant processes, reporting and control systems as well as the accompanying infrastructure. This function paid special attention to the processes of software development for the engine control unit. The Group Internal Audit function provided its findings to the external experts from Jones Day. The internationally renowned law firm was engaged by Volkswagen AG to fully clarify the facts and responsibilities in a second investigation. Jones Day has received operational support from the auditing firm Deloitte.

The special investigation has involved conducting interviews with employees and managers who were identified by Jones Day as relevant sources of information in connection with the diesel issue. In addition, Jones Day has evaluated documents and data (such as e-mails).

We will discuss the action taken in response to the audit findings at the end of this section.

Employees from affected departments have been dismissed as a further direct consequence of the findings from the internal inquiries and external investigations.

The information that has been viewed so far has helped trace the origin and development of the diesel issue to a large extent. The starting point of the diesel issue at Volkswagen was the strategic decision to launch a large-scale promotion of diesel vehicles in the USA in 2005. To this end, a new diesel powertrain unit featuring high performance and cost-efficient production – the EA 189 type engine – was to be developed.

The US emissions limits for emissions of pollutants are strict. Under the strictest standard in the USA at the time, only 31 mg/km of NO_x were allowed to be emitted, about one sixth of the Euro 5 standard applicable in Europe at that time. When designing state-of-the-art diesel engines, technicians and engineers face the challenge that there is a conflicting objective between the reduction of NO_x and other parameters.

In the ensuing period, in order to resolve this conflicting objective satisfactorily within the time frame and budget of the EA 189 project, a group of persons at levels below the Group’s Board of Management in the powertrain development division decided to modify the engine management software. In the engine controller of the vehicles with type EA 189 diesel engines there was a software that recognizes the driving curve of the official type test, regardless of whether the vehicle is on a test bench or on the road. Depending on the recognition of the driving curve the engine controller switches to 2 different modes: mode 1 optimum NO_x for test bench operation or mode 2 optimum particulate matter for road operation.

As things stand, outside the group of persons mentioned above, the then and current Board of Management of Volkswagen AG had, at any rate, no knowledge of the use of an unlawful “defeat device software” under US law at the time.

In the months after the International Council on Clean Transportation (ICCT) study was published in May 2014, the test set-ups on which the ICCT study was based were repeated in house at Volkswagen and the unusually high NO_x emissions confirmed. The US environmental authority of California – the California Air Resources Board (CARB) – was informed of this result, and at the same time the offer was made to recalibrate the type EA 189 diesel engines as part of a service measure that was already planned in the USA. This measure was evaluated and adopted by the Ausschuss für Produktsicherheit (APS – product safety committee), which includes, among others, employees from the technical development, quality assurance, sales, production, logistics, procurement and legal departments, as part of the existing processes within the Volkswagen Group. The APS thus plays a central role in the internal control system at Volkswagen AG. There are currently no findings to confirm that an unlawful “defeat device software” under US law was reported by the APS as the cause of the discrepancies to the persons responsible for preparing the 2014 annual and consolidated financial statements. Instead, at the time that the annual and consolidated financial statements were being prepared, this group of people remained under the impression that the issue could be solved with comparatively little effort as part of a field measure. By the summer of 2015, however, it was reliably recognized that the cause of the discrepancies was a software modification, that would qualify as a “defeat device” as defined by US environmental law. This culminated in the disclosure of the US “defeat device” to EPA and CARB on September 3, 2015. According to the assessment at that time of the members of the Board of Management dealing with the matter, the scope of the costs expected as a result by the Volkswagen Group (recall costs, retrofitting costs and financial penalties) was basically not dissimilar to that of previous cases in which other vehicle manufacturers were involved, and therefore appeared to be controllable overall with a view to the business activities of the Volkswagen Group. This appraisal by Volkswagen AG was based on the assessment of a law firm brought in in the USA for approval issues, according to which similar cases in the past were resolved amicably with the US authorities. Publication of a “Notice of Violation” by the EPA on September 18, 2015, which came as a surprise to the company, on the facts and possible financial consequences, then presented the situation in a completely different light.

To clarify the issue, Audi set up an internal task force, furnished committees with the necessary resources and launched a program of cooperation for employees covered by collective agreements in 2015. The law firm Jones Day also conducted independent and comprehensive investigations into this matter.

The incumbent members of the Board of Management of AUDI AG have declared as already in the previous year that prior to their notification by the EPA in November 2015, they had no knowledge of the use of an unlawful “defeat device software” under U.S. law in the V6 3.0 l TDI engines.

We are consistently seeking to realize organizational and procedural potential for improvement that has come to light as a result of the diesel issue.

Also, the publications released by the reporting date, as well as the continued investigations and interviews in connection with the diesel issue, did not provide the Group Board of Management with any new reliable findings or assessments regarding the underlying facts and the assessment of the associated risks (e.g. investor lawsuits).