In Brief

The effects of corporate scandals can reverberate for years. Volkswagen, whose conspiracy to hide the emissions of its diesel engine vehicles was first uncovered in 2015, is still trying to repair its reputation. The damage will be felt for some time to come. The authors raise a question that has not been asked throughout this case: Did the company’s auditors and attorneys miss opportunities to prevent the scandal?


Another high mileage mark is now in the Guinness World Records book … an impressive 81.17 mpg. Starting out from VW’s American headquarters in Herndon, Virginia on June 22 and returning July 7 … the record-setting 2015 Golf TDI covered 8,233.5 miles in traversing the 48 contiguous states while burning 101.43 gallons of Shell diesel that costs a total of $294.98.

—Bob Nagy, “VW Golf TDI Sets Fuel Economy Record,” Kelley Blue Book website, Jul. 8, 2015,

While the Volkswagen Golf TDI diesel was traversing the country in the summer of 2015, so were Volkswagen engineers, to meet with Environmental Protection Agency (EPA) and California Air Resources Board (CARB) officials. The regulators wanted to know why real-time emissions monitoring conducted on Volkswagen diesel vehicles on the open road had revealed up to 35 times the amount of pollution recorded when the same cars were monitored in a government testing facility.

On September 18, 2015, the EPA issued a Notice of Violation to Volkswagen after determining that the company had manufactured and installed software (known as “defeat devices”) that substantially reduced the effectiveness of the emissions control system of the diesel vehicles when on the open road. The violations spanned the course of six consecutive model years (2009–15). Signed by Phillip Brooks, director of the EPA’s Air Enforcement Division, the letter was addressed to various Volkswagen and Audi corporate entities and copied to Volkswagen’s outside counsel.

Volkswagen should have seen it coming days, months, or even years before. The day before the Notice of Violation, EPA and Volkswagen officials exchanged emails scheduling a high-level conference call the next morning at 9:00 a.m. The previous evening, Brooks, a veteran of the Justice Department’s Environmental Enforcement Section, sent Volkswagen an ominous follow-up to ensure its general counsel would be on the call: “Please note that this is a call that Mr. [David] Geanacopolus would probably want to make a priority.”

During the call, the general counsel learned of the Notice of Violation. This was just the first in an extraordinary series of events that ultimately would lead to costly litigation and criminal charges against Volkswagen and its CEO.

In 2016, Volkswagen was the defendant in a consolidated nationwide consumer class action and government civil enforcement action that resulted in a $15 billion settlement. In 2017, the company was fined $2.8 billion for criminal violations in the United States, and in 2018, it was fined the equivalent of $1.2 billion in Germany. By the end of the second quarter of 2019, Volkswagen’s costs associated with the scandal were over $32 billion and mounting as various legal proceedings continued around the world. Pending litigation includes charges filed by the SEC for defrauding bond investors and an unprecedented class action lawsuit in Germany.

These costs were incurred because Volkswagen engaged in an elaborate fraud that included the installation of software in diesel vehicles to fool government emissions tests, false certification to government authorities that the vehicles were compliant, deceptive marketing of the vehicles to consumers as “clean diesel,” and a brazen cover-up.

This conspiracy was not a victimless crime. Published research spearheaded by MIT scientists predicts that the excess particulate matter (PM) and nitrogen oxide (NOx) emissions produced by the fake clean diesel vehicles will lead to some 60 premature deaths in the United States and 1,200 in Europe (Steven Barrett et al., “Impact of the Volkswagen Emissions Control Defeat Device on U.S. Public Health,” Environmental Research Letters, Oct. 29, 2015,; Guillaume P. Chossière et al., “Public Health Impacts of Excess NOx Emissions from Volkswagen Diesel Passenger Vehicles in Germany,” Environmental Research Letters, Mar. 3, 2017,

To date, none of the auditors and lawyers associated with Volkswagen has been publicly identified as being the subject of any investigation connected with the scandal. Did any of them miss opportunities to help prevent it? This article provides a background sketch of the scandal; touches upon the state of Volkswagen’s corporate culture, governance, risk management, and sustainability practices at the time (i.e., its corporate DNA); and explores what standards applied to the auditors and lawyers based on the facts as reported to date. (To be clear, a review of the actions of VW’s auditors and lawyers is beyond the scope of this article.)


Environmental statutes such as the Clean Air Act (CAA) are largely predicated on protecting human health rather than the environment per se. Indeed, in a landmark unanimous opinion written by Justice Antonin Scalia, the Supreme Court construed the CAA as mandating the EPA to solely consider human health and welfare—and barring it from considering industry implementation costs—in promulgating national ambient air quality standards (NAAQS) for pollutants such as PM and NOx[Whitman v. American Trucking Associations, 531 U.S. 457, 473 (2001)].

Tighter air quality standards such as those upheld in American Trucking, together with increased enforcement authority and tools, have enabled the federal government, with the help of the states, to significantly reduce air pollution in recent years [Daniel Jacobs, “The Federal Enforcement Role in Controlling Ozone,” in McKee, D. (Ed.), Tropospheric Ozone: Human Health and Agricultural Effects, CRC Press, 1994]. Enforcement is critical to protecting human health, especially in major metropolitan areas such as Los Angeles, which sits in the most heavily polluted air basin in the country (American Lung Association, State of the Air 2018

To date, none of the auditors and lawyers associated with Volkswagen has been publicly identified as being the subject of any investigation connected with the scandal. Did any of them miss opportunities to help prevent it?

Controlling emissions from automobiles is an important means of reducing air pollution, especially in large cities. Since its creation in 1970, the EPA has been under a congressional mandate to promulgate regulations designed to reduce automobile emissions. In 1990, Congress enacted new emissions laws known as Tier 1 standards and required the EPA to review whether further reductions were necessary and technologically feasible to help states meet the NAAQS. In 2000, the EPA finally issued more stringent Tier 2 standards, including for NOx and PM, which were phased in gradually in automobiles and were in full force beginning with model year 2007.

Thus, the new emissions requirements were designed to protect people’s health; they evolved over time, giving automobile manufacturers both ample notice and time to comply; and they were based on available technology. In other words, they were necessary, reasonable, and achievable. But they posed a dilemma for Volkswagen if it was to achieve its ambition of becoming the leading automobile manufacturer in the world.

In 2007, with a new CEO at the helm, Volkswagen launched “Strategy 2018,” an aggressive new initiative with goals such as doubling annual vehicle sales (Stefan Schmid and Phillip Grosche, “Managing the International Value Chain in the Automotive Industry,” Bertelsmann Stiftung, 2008, A key part of that strategy was to vastly expand diesel vehicle sales in the United States (Jack Ewing, Faster, Higher, Farther: The Volkswagen Scandal, W.W. Norton & Company, 2017). To that end, in 2008 Volkswagen rolled out a new technology that it claimed would achieve high fuel economy and performance while meeting the strict new emissions standards—a technology that seemed to require “magical thinking,” at least in engineering circles (Dune Lawrence et al., “How Could Volkswagen’s Top Engineers Not Have Known?” Bloomberg Businessweek, Oct. 26, 2015,

Volkswagen solved its dilemma by engaging in an elaborate fraud. By Volkswagen’s estimation, complying with the rules meant increased costs and lower fuel economy and road performance, which would potentially detract from sales. So, Volkswagen took it upon itself to use defeat devices to cheat—programming the vehicles so that their emission control systems satisfied emission limits only when in test mode. When on the road, the systems were disabled.

Knowing that the diesel vehicles would evade U.S. emissions standards, Volkswagen misrepresented them for years in order to get EPA and CARB certifications that allowed the vehicles to be sold in the U.S. When EPA and CARB finally began to catch on, Volkswagen equivocated until regulators threatened to withhold certification of its 2016 model year diesels. Once it became clear that its number was up, Volkswagen destroyed evidence of the fraud.

Volkswagen’s Corporate Culture and Governance, Sustainability, and the Six Capitals

During the years it perpetrated this fraud, Volkswagen consistently portrayed itself as having an ethical culture, good corporate governance, effective risk management, and a strong commitment to sustainability. There is evidence to the contrary. For example, Fortune has reported that Volkswagen has “a history of scandals and episodes in which it skirted the law” (Geoffrey Smith and Roger Parloff, “Hoaxwagen,” Mar. 7, 2016, Volkswagen’s ownership and governance structures, including voting rights and the makeup of its supervisory board, were not a recipe for good corporate governance (Charles Elson et al., “The Bug at Volkswagen: Lessons in Co-Determination, Ownership, and Board Structure,” Journal of Applied Corporate Finance, December 2015,, and the Volkswagen CFO apparently did not play the role of “Chief Value Officer,” as envisioned by Mervyn King (“Commonsense Principles of Corporate Governance,” The CPA Journal,July 2017, Volkswagen’s own internal auditors—after the fact—recommended 31 measures to improve governance and compliance (Volkswagen Group Annual Report 2016, Meanwhile, all three pillars of sustainability—economic, social, and environmental—collapsed under the diesel fraud, as costs mounted, stakeholders were alienated, and the air was polluted.

Volkswagen took it upon itself to use defeat devices to cheat—programming the vehicles so that their emission control systems satisfied emission limits only when in test mode.

By the measure of the six capitals of integrated reporting—financial, manufactured, intellectual, human, social and relationship, and natural—that have gained favor in recent years, Volkswagen also suffered dearly (Jane Gleeson-White, Six Capitals, or Can Accountants Save the Planet? W.W. Norton & Company, 2014; Barry Melancon, Keynote Address from 1st Annual NYSSCPA Hedge Fund Roundtable Sustainability Investment Leadership Conference, The CPA Journal, June 2016, The diesel fraud exposed Volkswagen to huge tangible and intangible risks, and the consequences significantly depleted tangible financial capital (over $30 billion in costs, significant drop in stock price); social and relationship capital (diminished brand name and trust, damaged stakeholder relations), and natural capital (increased pollution, associated morbidity and mortality).

Audited Financial Statements and Potential Warning Signs

As a publicly traded company, Volkswagen’s annual financial statements are subject to independent audit. Several standards of the International Auditing and Assurance Standards Board (IAASB) may be particularly relevant as to whether any of the annual audits conducted during the period of the fraud could have detected potential warning signs (2016-17 Handbook of International Quality Control, Auditing, Review, Other Assurance, and Related Services Pronouncements,

International Accounting Standard (IAS) 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment, requires auditors to evaluate whether “management, with the oversight of those charged with governance, has created and maintained a culture of honesty and ethical behavior” (para. 14). Furthermore, auditors must gain an understanding of the company’s “relevant industry, regulatory, and other external factors,” “its operations,” and “its ownership and governance structures” (para. 11). Awareness of a toxic corporate culture and poor ownership and corporate governance structures might prompt the auditor to consider how those factors could affect business practices and controls, and potentially lead to fraud.

ISA 240, The Auditor’s Responsi bilities Relating to Fraud in an Audit of Financial Statements Auditors, states that auditors are “responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error” (para. 5). Fraudulent financial reporting includes “misrepresentation in, or internal omission from, the financial statements of events, transactions, or other significant information” (para. A3). Auditors should also keep in mind the three points of the fraud triangle: incentive or pressure, opportunity, and rationalization (para. A1).

Auditing standards also require auditors to consider a company’s legal and regulatory environment (ISA 250, Consideration of Laws and Regulations in an Audit of Financial Statements), including “undertaking specified audit procedures to help identify noncompliance with those laws and regulations that may have a material effect on the financial statements” (para. 7).

Application of these standards to the Volkswagen scandal raises a number of questions. Should the auditors have exercised additional scrutiny under the circumstances—which included a history of poor ethical corporate culture, weak corporate governance, an aggressive new sales strategy, and bold claims of technological advances? Might they have focused more heavily on assessing the control environment and fraud risk factors? Did the members of the audit team have sufficient industry expertise to assess business and audit risk, given the negative consequences that the nondetection of fraud can have, not just for the company and its stake-holders, but also for the audit firm?

Sustainability Reports and Limited Assurance

The two most common assurance frameworks used for sustainability reports are ISAE 3000 and AA1000AS (Sunita Rao, “Current State of Assurance on Sustainability Reports, The CPA Journal, June 2017, ISAE 3000 is used more often by CPA firms (primarily the Big Four), and AA1000AS is used more often by “specialist assurance providers/technical experts” (Rao 2017). ISAE 3000 allows for “moderate” or “limited” assurance [ISAE 3000 (Revised), 2013, para. 6], while AA1000AS allows for “high” or “moderate” assurance (AA1000AS, 2008, p. 10).

Should the auditors have exercised additional scrutiny under the circumstances—which included a history of poor ethical corporate culture, weak corporate governance, an aggressive new sales strategy, and bold claims of technological advances?

From 2008 to 2013, Volkswagen’s sustainability reports, prepared by the same firm that performed the financial audits, contained independent assurance reports that were conducted under both AA1000AS and ISAE 3000, whereas for 2014 and 2015, they were conducted only under ISAE 3000. Starting with the 2015 sustainability report, the auditor makes clear that its assurance, even though limited, should not be relied upon by stakeholders: “The report is not intended for any third parties to base any [financial] decision thereon. We do not assume any responsibility towards third parties.” In the 2017 report, the sentence “Our responsibility lies only with the Company” was added to the report between the two sentences above.

Thus, the independent assurance provided for Volkswagen’s sustainability reports became increasingly more limited over time. Would society and stakeholders be better served by sustainability reports at higher levels of assurance that are designed to more fully inform stakeholder decisions? Could greater scrutiny, in the form of more proactive and comprehensive inspections and assessments by the sustainability report assurance firm, have detected the use of the defeat device, to the ultimate benefit of Volkswagen and its stake-holders? Would it have been beneficial to have different firms conduct the audits of the financial reports and sustainability reports, or did the use of the same firm actually provide a greater opportunity to discover the fraud? These questions and many others might be addressed more definitively with greater access to records that Volkswagen has yet to make publicly available.

The Lawyers

As in earlier corporate debacles where the role of the company’s lawyers has come into question (such as the Enron accounting scandal and the General Motors ignition switch case), observers might ask: what duty, if any, did Volkswagen’s lawyers have to report the fraud if they knew of it?

It is possible that what Volks-wagen’s lawyers knew and when they knew it has been addressed by Jones Day, the powerhouse law firm VW hired after the fact to conduct an internal investigation of the fraud. To date, however, the Jones Day information, which was provided to the Justice Department as part of a successful effort to win a reduction in Volkswagen’s criminal fine of over $3 billion, otherwise remains secret, requests notwithstanding. (German authorities searched the law firm’s offices in Munich to seize the information, an action that was subsequently upheld by Germany’s Constitutional Court.)

The duties of lawyers are discussed in the canons of ethics that generally govern the legal profession (each jurisdiction is different), which were revised after the passage of the Sarbanes-Oxley Act of 2002 (Cramton et al., Legal and Ethical Duties of Lawyers After Sarbanes-Oxley, 49 Villanova Law Review, January 2004, Under the Model Rules of Professional Conduct adopted by the American Bar Association (ABA), a lawyer may not ethically facilitate conduct that he knows to be illegal or fraudulent (ABA Model Rule 1.2). The rules reflect, however, a distinct tension between the client’s right to confidentiality with the lawyer and the lawyer’s ethical obligations, with confidentiality generally weighing more strongly in the balance. Thus, under the Model Rules, a lawyer may—but is not required to—report to the authorities the unlawful conduct of a client “to the extent that the lawyer reasonably believes necessary … to prevent the client from committing a crime or fraud that is reasonably certain to result in substantial injury to the financial interests or property of another and in furtherance of which the client has used or is using the lawyer’s services” [ABA Model Rule 1.6(b)(2)].

Comments to the ABA Model Rules reflect that the scenario is “especially delicate” when the lawyer has been representing a client with the understanding that the conduct was legal, but then discovers the criminal or fraudulent conduct midstream. The lawyer may not assist the client in such conduct and must withdraw at that stage (Comment 10 to Model Rule 1.2).

Would society and stakeholders be better served by sustainability reports at higher levels of assurance that are designed to more fully inform stakeholder decisions?

The Model Rules also contain provisions that relate specifically to circumstances where a lawyer is representing an organizational client, such as a corporation. If the lawyer knows of a violation of law that is likely to result in substantial injury to the corporation, the lawyer must act in the corporation’s best interest (i.e., not necessarily in the best interest of its individual officers and employees), including by reporting the matter up the corporate ladder [Model Rule 1.13 (b)]. In some jurisdictions, if reporting up the ladder does not result in the matter being addressed appropriately, the lawyer may—but is not obligated to—report a clear violation to the authorities if it is reasonably certain to result in substantial injury to the corporation [Model Rule 1.13(c)].

Thus, the applicable obligations generally can be summarized as follows, based on what the lawyer knew and when:

  • The lawyer never knew about the illegal or fraudulent conduct: No legal or ethical violations
  • The lawyer knew about the illegal or fraudulent conduct and helped perpetrate it: ethical violation (and potentially legal violation)
  • The lawyer learned about the illegal or fraudulent conduct midstream: must withdraw and report internally, and may report externally if sufficiently serious.

No Clear Answers

Volkswagen engaged in a massive fraud with dire consequences for the company and its stakeholders alike. Its corporate culture facilitated both the conception and perpetuation of the charade. It remains an open question, however, whether Volkswagen’s auditors and lawyers might have missed opportunities to prevent the scandal.

Daniel Jacobs, JD is a clinical associate professor of management at the College of Business Administration of Loyola Marymount University, Los Angeles, Calif.
Lawrence P. Kalbers, PhD, CPA is the R. Chad Dreier Chair in Accounting Ethics and the associate dean, faculty and academic initiatives at Loyola Marymount.