Can Volkswagen Ride Out The Storm?

Image and legal problems could sideswipe its recovery--and CEO

Just a few weeks ago, Ferdinand Piech was riding high. After four years at the wheel, Volkswagen's intense chief executive had driven Europe's largest carmaker out of the ditch and well along the road to recovery. Aggressive pricing and a string of hit products have been grabbing market share both in Europe and the U.S. Profits in the nine months ended Sept. 30 more than doubled, to $305 million on sales of $49 billion. The company's stock was soaring to $410 a share, close to its all-time high.

But now, the 58-year-old grandson of VW founder Ferdinand Porsche has been sideswiped by festering legal and image problems. Ace cost-cutter Jose Ignacio Lopez de Arriortua, whom Piech lured to VW from General Motors Corp. in 1993, is expected to be charged soon by German prosecutors with stealing GM secrets. In the U.S., VW, Lopez, Piech, and other top executives face a civil lawsuit in which GM may seek up to $4 billion in damages. A grand jury in Detroit continues its criminal investigation. Finally, a new book published in Germany and--much to its regret--underwritten by VW, chronicles VW's use of slave labor during the Third Reich.

FALLOUT. All of this could shake the German company deeply. A hefty judgment or settlement in the U.S. could drain funds desperately needed for new products. Moreover, Piech himself may face hard questions from shareholders and members of his supervisory board about his recruitment of Lopez and his handling of the crisis--including exactly what he knew and when. "This could create fallout for VW's management board," which is headed by Piech, says Klaus Tiedemann, law professor at the University of Freiburg. VW says the fact that no other top managers have been indicted proves their innocence. "There is no evidence of a conspiracy," says spokesman Klaus Kochs, a VW managing director.

After a three-year investigation marked by dramatic police raids on VW headquarters in Wolfsburg, German prosecutors in Darmstadt appear poised to charge Lopez. In early November, Lopez' lawyer, Jurgen Taschke, said he expects an indictment by the end of the month. Three co-workers who had jumped to VW from GM with Lopez will likely also face charges. Lopez refused to comment and Piech would respond only through Kochs. However, legal experts say the trial may also raise doubts about the behavior of other company executives. "It would be very hard for VW to completely isolate Lopez and blame it all on [him]," says John M. Olin, a Yale University law professor.

If Lopez is indicted, a guilty verdict is far more likely than in a typical U.S. case. German prosecutors investigate cases intensively and bring indictments only when they're fairly sure they can win. In practice, that means about 80% of those indicted are convicted. If found guilty, Lopez could face up to five years in prison and stiff fines, though a suspended jail sentence would be likely, say German legal experts.

A Lopez indictment could also give a push to GM's civil suit in U.S. District Court in Detroit. Legal experts say the German proceedings would lend credence to GM's charges that Lopez stole sensitive price lists for parts, secret information about future products, and plans for an experimental new factory. GM hasn't officially set the damages it seeks. But people familiar with the company's deliberations say the sum could reach $4 billion. U.S. District Court Judge Nancy G. Edmunds in Detroit is scheduled to decide before the end of November whether to consider the case under provisions of the Racketeering Influenced & Corrupt Organizations Act (RICO), which allows triple damages. Legal experts, however, deem such a designation unlikely because it would require proving a long history of conspiratorial behavior.

To add to these woes, a grand jury in Detroit is investigating possible criminal violations by Lopez and VW. A state supreme court in Frankfurt will decide as soon as mid-November whether to allow German prosecutors to share material evidence with their U.S. counterparts. GM sources say the Darmstadt prosecutor's office has prepared materials for shipping and awaits the O.K. Detailed information seized in German police raids could give U.S. investigators the firepower they need to pursue their own criminal indictments. Kochs contends U.S. investigators will have difficulty finding evidence of a conspiracy where German prosecutors failed.

On top of all that, a World War II-era scandal threatens to engulf both VW and the Piech family. German historian Hans Mommsen recently published a 1,056-page book chronicling VW's unsavory behavior during World War II. In The Volkswagen Factory and Its Workers in the Third Reich, Mommsen details how VW used forced labor to build personnel carriers, mines, tank components, and other war goods. He says laborers ranging from Russian prisoners of war to Jewish concentration camp inmates toiled at the company's main factory. The workers were chronically malnourished and sometimes beaten, on occasion to death.

HIMMLER CONNECTION. Mommsen also explains how VW founder Porsche played to Adolf Hitler's love of technology to help the company flourish during the war. And how his contact with SS chief Heinrich Himmler eased the way for VW to use inmates from the Laagberg concentration camp to help construct a foundry. Piech's father, Anton, was named general manager in 1943 and oversaw the plant's operations.

This confluence of troubles may turn up the heat on Piech himself. If evidence surfaces during Lopez' trial that Piech knew of wrongdoing and supported Lopez anyway, he could lose support within the company's 20-member supervisory board. Likewise, a costly judgment or settlement in Detroit could erode his board support. Already, unhappiness with Piech's handling of the Lopez flap caused Chairman Klaus Liesen earlier this year to replace Piech's top public-relations executive with his own appointee, Kochs. With Piech's contract set to expire next year, the supervisory board would have a convenient means to cut him loose. "For the first time, Mr. Piech is in danger," says a former top VW executive.

For VW, this is a delicate moment. A turnaround is under way. Its marketshare is up half a point to 17.5% in Europe. In the U.S., it only has 1.1% of the market, but the trend is upward, too. But even Piech admits the recovery is far from complete. The company's 0.6% net margin is still abysmally low. Piech's bold plan to consolidate VW's confusing array of 16 car platforms down to just four by 1998 is only halfway complete. And the launch of a replacement for the company's all-important Golf model, which accounts for nearly half of VW's European sales, is just a year away.

Most company observers believe Piech will soon dump Lopez, in part out of self-protection. VW could certainly stand the loss, since most of Lopez' contribution to cost-cutting came early on as he erased VW's losses by squeezing suppliers for price reductions. As for Piech, Kochs says, "I'm very, very sure that Piech will get a second [five-year] contract." Maybe. But he'll have a lot of questions to answer before then.

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