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Lessons From Volkswagen's Emissions Fraud Disaster

For years, Volkswagen sold millions of cars designed to evade environmental controls. The company installed "defeat device" software which cheated emissions tests and disabled pollution controls when its diesel cars were on the road, allowing them to release 40 times the legal pollution limits. And they would have gotten away with it, too, if it weren't for those meddling environmentalists!

It's safe to say that Volkswagen's emissions fraud has been a complete disaster -- and not just for the environment. VW's weak position in the United States is bound to become even weaker and the company's stock lost almost a quarter of its value. Now VW must recall millions of vehicles, face up to billions in fines, and possibly face criminal prosecution. Here's what you can learn from Volkswagen's debacle.

Volkswagen's Emissions Cheat

In brief, Volkswagen installed "defeat device" software that engaged its diesel car's pollution controls when it detected that cars were undergoing emissions testing. On the road, those pollution controls were shut off, allowing huge amounts of nitrous oxide and other pollutants to be released, far in excess of what was allowed by EPA and California regulations. (Under the Clean Air Act, California is the only state allowed to set stricter auto pollution standards than the EPA.)

The cheat allowed VW and Audi vehicles to maintain promised fuel efficiency and performance standards that would have been impossible with proper pollution controls. All VW and Audi diesel vehicles sold from 2009 to 2015 seem to have had the cheat installed. All those cars now need to be recalled.

Know When Regulations Have Bite

Rule number one: know your regulations and know which ones can hurt you the most. The Clean Air Act empowers the EPA much more than normal government regulatory agencies.

The National Highway Traffic Safety Administration, for example, can't fine an automaker more than $35 million for breaking car safety laws. (Hence, GM's relatively soft punishment for using faulty ignition switches that killed over 100 people.) Clean Air Act violations, in contrast, can cost companies $37,5000 per vehicle -- or up to $18 billion in fines, in VW's case. Intentional violations can result in criminal charges -- something the Department of Justice's Environmental and Natural Resources Division is already pursuing.

Governments Aren't the Only Investigators

The fraud was discovered when a European environmental nonprofit was trying to convince EU states to adopt stricter, American-style auto pollution controls for diesel cars. They hired researchers at the University of West Virginia Center for Alternative Fuels, Engines, and Emissions, who tested the cars in real world conditions and discovered the fraud. From there, the California Air Resources Board learned about the cheating and then the EPA. Even then, for a year VW claimed the discrepancies were technical errors, only admitting the fraud when the EPA threatened to withhold approval for its new vehicles.

Remember Reputational Risk

Volkswagen and Audi vehicles haven't done well in the American market. In the EU, almost 60 percent of new cars are diesel vehicles like VW's. In the U.S., they were less than one percent of new cars, but of that small sliver, VW lines like Jetta dominated -- often because of their promise of lower emissions and better fuel efficiency.

Owners of Volkswagen vehicles are outraged by the news of the company's emissions scam, according to The New York Times, and its already small share of the market is expected to plunge if not disappear. The scandal "could be a black eye" for diesel technology itself, according to Don Anair of the Union of Concerned Scientists.

Companies That Cheat Need to Be Ready to Pay

And pay and pay. First, there's the $18 billion in possible per-car fines for violating the Clean Air Act. Then there are any fines or civil actions instituted by the California Air Resources Board, in addition to the EPA. The costs of recalling and fixing the cars will also fall on Volkswagen, which says it's setting aside $7.3 billion dollars to cover those costs, the equivalent of half a year's profits. Then, of course, there are the inevitable consumer law suits, class actions, and stock losses.

Add it all up and we're guessing that Volkswagen now thinks its cheat wasn't worth it.

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