Volkswagen trial offers hedge funds a chance to settle old scores
A subsidiary of Elliott Management is bankrolling a group of institutional investors who are suing Volkswagen because of the losses they suffered as a result of the company’s emissions cheating
Frankfurt, Germany: A decade ago, an epic stock market battle between Volkswagen’s biggest shareholder and a group of mostly US hedge funds ended badly for the investors. Now, for at least one of those funds, it is payback time.
Elliott Management, the hedge fund founded by Paul E. Singer, was among the firms burned in 2008 trying to bet against Volkswagen shares. The stock price rose instead, and while the funds claimed market manipulation, they never found a court that would agree.
Now a new case offers Elliott a chance at redemption. A subsidiary of the fund is bankrolling a group of institutional investors who are suing Volkswagen because of the losses they suffered as a result of the company’s emissions cheating. A German court will begin hearing evidence in the case Monday.
The trial is part of a group of similar suits claiming €9 billion (more than $10 billion) in damages. For the first time, high-ranking Volkswagen executives may testify in open court about the origins of the scandal. Interest in the case is so intense that the proceedings will be held in a convention center in Braunschweig, near Volkswagen’s headquarters — none of the local courtrooms could handle the expected crush of lawyers, plaintiffs, journalists and spectators.
The shareholders backed by Elliott, including the California state teachers’ pension fund and the fund that invests Norway’s oil wealth, are seeking €2 billion in damages, or about a fifth of the total claims.
Elliott is paying the upfront costs of bringing the suit, and will collect up to 30% of any winnings, according to its subsidiary Bentham Europe. The practice is known as litigation funding, and effectively turns court cases into investment opportunities. Elliott declined to comment.
Overall, roughly 4,000 shareholders have filed suits in various German courts, including hundreds of individuals. Fewer than half of those cases will be at issue in Braunschweig on Monday, and the outcome of that trial will set a precedent for the others.
Volkswagen has tried to portray the Braunschweig case as a crusade by greedy speculators. The carmaker has already paid nearly $32 billion in settlements and fines over the diesel scandal. Loyal, long-term shareholders will suffer even more, it argues, if it has to shell out additional billions in court judgments.
The case, Volkswagen said in a defense brief, is “essentially a struggle to redistribute the economic consequences of the diesel matter between new investors and old shareholders.”
The lawsuits in Braunschweig contend that the carmaker illegally kept shareholders in the dark about risks.
The scandal involved illegal software in vehicles that could detect when an emissions test was taking place, and then crank up pollution controls. At other times the vehicles polluted far more than allowed.
Shareholders blame Volkswagen managers, including Martin Winterkorn, the chief executive at the time, for the huge losses they suffered after the deception came to light in September 2015. Volkswagen’s stock price plunged nearly 40%, wiping €25 billion off the company’s stock market value. The shares have yet to fully recover.
Volkswagen, which has refused to settle the case, contends that the wrongdoing was the work of engineers and managers at a level below the management board.
Even after top-level managers learned of the cheating, the company contends, they were blindsided by its effect. It has argued in court documents that it could not have predicted the astronomical cost of fines and civil settlements with Volkswagen owners.
Lawyers for the shareholders argue that ignorance is no excuse.
“All that counts,” said Nadine Herrmann, a partner at the law firm Quinn Emanuel Urquhart & Sullivan who is representing the investors financed by Elliott, “is whether Volkswagen, its board members and senior executives could have known about the emissions fraud if they had not deliberately or with gross negligence turned a blind eye.”
For Singer and his hedge fund, the case offers an opportunity to make money — but also to even the score after winding up on the losing end of a notorious clash.
In 2008, Porsche Holding, the family company that owned the maker of Porsche cars, was in the midst of an audacious bid to take over Volkswagen, with which it had a manufacturing partnership and a long shared history. Porsche Holding was established by the descendants of Ferdinand Porsche, who designed the Volkswagen Beetle for the Nazis in the 1930s.
While Volkswagen made far more vehicles than Porsche, Porsche was more profitable. The family company tried to leverage its financial might into outright control of Volkswagen. The takeover attempt was financed with a complicated derivatives scheme that depended on Volkswagen shares maintaining their value.
But the plan was thrown into doubt by the market panic that followed the collapse of the Lehman Bros. investment bank.
Hedge funds, including one managed by Elliott, began targeting Volkswagen stock, betting that the company was vulnerable. They used a risky strategy known as short selling. They sold borrowed shares in anticipation of buying them back later at a lower price and pocketing the difference.
It was a zero sum game. Porsche desperately needed Volkswagen shares to rise. The short sellers were just as eager for the stock price to fall.
The clash came to a head on 26 October 2008, a Sunday. The Porsche holding company issued a statement that, hedge funds later contended, falsely created the impression that almost all of Volkswagen’s voting shares were locked up. That implied few shares were left for the short sellers to cover their bets, exposing them to huge losses.
In the panic buying that followed after markets opened the next day, Volkswagen shares rose so much that it was briefly the most valuable company in the world.
The maneuver rescued Porsche’s takeover bid, allowing the family company to acquire majority voting rights in Volkswagen.
For hedge funds, though, the episode was a disaster. They were billions of dollars poorer, and later sued Porsche Holding, saying the 26 October statement was misleading and an illegal attempt to manipulate the shares. In fact, they contended, Porsche Holding was on the verge of running out of money and would soon have been forced to dump thousands of Volkswagen shares on the market.
German prosecutors pursued criminal charges against two top Porsche executives. But trials ended in acquittal, while a judge in the United States ruled that US courts did not have jurisdiction. Other lawsuits related to the 2008 episode are still crawling through German courts.
Elliott has also sued Porsche Holding separately, accusing the company of violating German stock market laws in connection with the diesel scandal.
The lawsuit going to trial in Braunschweig on Monday is a classic case of who knew what when. Under German law, members of a company with publicly traded stock are obliged to warn shareholders about risks that could affect the share price.
The plaintiffs are trying to prove that members of Volkswagen’s top management knew about the illegal emissions scheme months, if not years, before the Environmental Protection Agency revealed its existence. Volkswagen, however, has maintained that members of its management board were ignorant of the cheating.
That contention is getting harder to defend. In May, the US Department of Justice indicted Winterkorn, the former chief executive, on charges of wire fraud and conspiracy related to the emissions cheating. According to the indictment, Winterkorn was informed about the illegal software in May 2014, more than a year before Volkswagen finally disclosed it to authorities.
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