The Securities and Exchange Commission had a tough go of it at a hearing Friday before U.S. District Judge Charles Breyer of San Francisco, who is overseeing the SEC’s securities fraud case against Volkswagen. It’s just not a good day for the government when a judge feels compelled to point out that the bird in your agency’s symbol is an eagle, “not a carrion hawk that simply descends when everything is all over and sees what it can get.”
Judge Breyer, as Reuters reported, ordered the SEC to detail precisely why it waited until March 2019 to file its complaint stemming from VW’s emissions cheating scandal – nearly three years after the company reached a $10 billion class action settlement with car owners and two years after VW pleaded guilty in the Justice Department’s criminal case.
Though the SEC’s Daniel Hayes said at Friday’s hearing that the SEC acted as quickly as it could and sued only after settlement talks failed, timeliness, clearly, is going to be an issue for the SEC. Judge Breyer, who has been overseeing all VW emissions cheating litigation since the cases were consolidated in a nationwide MDL at the end of 2015, well knows that private securities fraud claims have been underway for years.
In fact, a bondholder in one of the offerings at issue in the SEC’s case filed a prospective class action in June 2016 – a full year before the SEC issued VW a subpoena on $8 billion in bond offerings to sophisticated investors in 2014 and 2015. Judge Breyer flat out said he was “skeptical” about the SEC’s explanation for waiting until 2019 to sue and warned the SEC’s lawyers that he needed a good answer “before this litigation moves to the second step.” (The SEC did not respond to an email requesting comment on the VW case.)
Timeliness, however, is not VW’s only argument against the SEC’s case. The company has not yet filed its motion to dismiss the suit. But a joint case management report filed on May 3 – and a remark by Judge Breyer at Friday’s hearing – hint explicitly at the additional dismissal arguments we can expect from VW’s lawyers at Sullivan & Cromwell. (I’m talking here about arguments on behalf of the company, not for former VW CEO Martin Winterkorn, who is also a defendant in the SEC suit but contends that U.S. courts do not have personal jurisdiction over him in the case and that he was unaware of VW’s efforts to cheat on emissions testing before the bond offerings.)
VW’s chief alternative attack on the SEC case will be that the agency is asserting an unprecedented theory that investors were defrauded because the company would have had to pay higher interest rates on corporate bonds and asset-backed securities had it not misrepresented emissions data for its diesel cars.
The SEC, according to VW, cannot claim that investors lost money. Although its complaint alleges that VW’s bond prices fell by 7% when the company’s emissions cheating fraud was revealed in September 2015, VW says the bonds at issue in the SEC case have all been or will imminently be repaid in full, without a missed payment. The asset-backed securities in the SEC’s case were also paid in full, according to VW.
VW lead lawyer Robert Giuffra of S&C told me in an email statement that he’s not aware of any previous instance in which the SEC has sued the issuer of ABS or bonds available only to sophisticated, qualified investors when those investors received all promised payments and the bonds did not dip below investment grade. Similarly, Giuffra said, he knows of no previous case in which the SEC alleged that sophisticated bond investors were injured because they didn’t receive a higher interest rate because of undisclosed risk. He warned that the SEC’s theory, if the commission prevails against VW, could impact the broader market for automotive bonds. Carmakers, he said, “must now fear an SEC enforcement action in response to any vehicle recall, in an industry where recalls are common occurrences.”
Davis Polk & Wardwell and Simpson Thacher & Bartlett both noted the SEC’s unusual theory in client memos issued after the SEC filed its suit. Simpson’s memo said the SEC “would appear to have adopted an expansive view of materiality” to claim fraud on securities that performed as promised. Davis Polk said the case “raises questions about the appropriate method of ascertaining benefits from allegedly fraudulent bond or other debt offerings, especially where there has been no default on the performance of the debt.”
VW also seems poised to argue, based on the May 3 filing that the SEC’s theory must fail because the market for the bonds it sold in the U.S. is not efficient. Only qualified investors were permitted to buy the particular bonds VW sold, so, according to the company, the investor pool was too small to assure that the price of the securities accurately reflected public information. Judge Breyer agreed with VW about the VW bond market’s inefficiency in a 2018 ruling in the private fraud class action over the bonds, holding that bond investors could not invoke the presumption that they relied on VW’s alleged misstatements. But Davis Polk’s memo suggested that the SEC, unlike private investors, need not plead reliance.
If other defenses fail to ward off a liability finding, VW appears likely, based on the May 3 filing, to argue that fairness precludes any disgorgement to the SEC. For one thing, the company argued, it has already settled allegations related to its asset-backed securities as part of its January 2017 deal with the Justice Department, which included a release of the government’s civil fraud claims. (The SEC said its claims are not covered by the release.) For another, VW said, it has already paid more than $20 billion, or nearly $40,000 per car, to resolve civil and criminal claims in the U.S., way more than any allegedly ill-gotten profits. Any additional disgorgement, it said, would amount to an “unnecessary, redundant and excessive” penalty, and would be particularly inappropriate in a case in which investors were paid all they were promised.
Judge Breyer signaled some sympathy with VW’s fairness argument at Friday’s hearing, circling back to the SEC’s delay in filing its suit. “You seek equitable relief,” he said to the SEC’s lawyers. “In order to seek equity, you must do equity … One of the principles that is involved is the speed with which you move in order to seek the relief you are demanding.”
The judge wants to hear the SEC’s detailed explanation for the timing of its suit by July. That should give him a lot to think about.
(This article has been corrected. A previous version included an incorrect due date for VW’s dismissal motion.)
Reporting by Alison Frankel
The views expressed in this article are not those of Reuters News.