VW ex-boss Martin Winterkorn investigated over fraud allegations

The German company also suspended three top engineers, sources familiar with the matter told Reuters, as it tries to get to grips with a crisis that has knocked more than a third off its market value and could harm Germany's economy.

Volkswagen has admitted cheating diesel emissions tests in the United States but Germany's transport minister says it also manipulated tests in Europe, where it has much bigger sales, and it faces the worst business crisis in its 78-year history.

MUST READ: How VW's scandal threatens the reputation of 'German engineering'

The German prosecutor's office said it was investigating Winterkorn over "allegations of fraud in the sale of cars with manipulated emissions data" based on charges filed by about 10 unidentified individuals.

Winterkorn, replaced as chief executive on Friday by company veteran Matthias Mueller, said when he quit last week that he was not aware of any wrongdoing on his part and wanted to give the company a new start.

The crisis is an embarrassment for Germany, which has for years held up Volkswagen as a model of its engineering prowess and has lobbied against some tighter regulations on automakers. The German car industry employs more than 750,000 people and is a major source of export income.

"The car industry is crucial for the German economy. It (the scandal) can have a big impact on the German economy," Deputy Finance Minister Jens Spahn told a conference.

In a sign of Volkswagen's own efforts to tackle the crisis, sources close to the matter said it had suspended Heinz-Jakob Neusser, head of brand development at its core VW brand.

Also suspended were Ulrich Hackenberg, the head of research and development at premium brand Audi who oversees technical development across the group, and Wolfgang Hatz, R&D chief at sports-car brand Porsche who heads group engine and transmissions development, they said.

One source said Hackenberg was taking legal action against the decision. Volkswagen and Audi declined to comment, while the suspended executives could not immediately be reached.

Winterkorn, who was at the helm of Volkswagen for nine years and was the highest paid CEO on Germany's blue-chip DAX stock market last year, also could not be reached for comment.

A source close to Volkswagen's board said its executive committee would meet on Wednesday to discuss the appointment of U.S. law firm Jones Day to lead an external investigation.

But the crisis shows no sign of dying down.

Two German newspapers said on Sunday Volkswagen's own staff and one of its suppliers had warned years ago about the illegal use of so-called "defeat devices" to detect when a car was being tested and alter the running of its diesel engine to conceal their emissions of toxic nitrogen oxides.

Environmental campaign group Transport & Environment (T&E) said on Monday there was a wider industry problem, as it published new data showing some new Mercedes, BMW and Peugeot cars use 50 percent more fuel than laboratory tests indicate.

T&E said its data did not prove other firms were using defeat devices. But it said the gap between lab and road tests had grown to such an extent for emissions of both carbon dioxide and nitrogen oxides that further investigation was needed to discover what carmakers were doing to manipulate results.

"The Volkswagen scandal was just the tip of the iceberg," said Greg Archer, clean vehicles manager at T&E, adding the gap between lab tests and road performance cost a typical driver 450 euros ($504) per year.

ACEA, the European Automobile Manufacturers' Association, which represents top carmakers, has said there is no evidence the use of defeat devices is an industry-wide issue.

In a statement on Monday, it said it supported the development of updated testing. U.S. and European regulators have said they are working on tighter rules.

Volkswagen's market value has fallen by more than 25 billion euros since it admitted to cheating U.S. emissions tests. It faces investigations and potential fines from regulators and prosecutors, as well as lawsuits from cheated customers.

Customers and dealers have criticised a lack of information from the company about what will happen to the 11 million vehicles it has said were fitted with defeat devices worldwide.

There were signs on Monday the vehicles would be recalled and refitted, with Volkswagen's Swiss distributor saying a plan to refit almost 129,000 cars in its country would be presented to Swiss transport authorities in October.

Volkswagen's flagship Audi brand said 2.1 million of its cars were affected by the scandal, including the A1, A3, A4, A5, A6, TT, Q3 and Q5 models.

Spain's industry minister said he would ask Volkswagen's local Seat brand to pay back subsidies it had received for 'fuel-efficient' cars that broke rules.

"VW is in a dramatic situation. It will be far from easy to restore the reputation of the company and win back trust from customers," new CEO Mueller said in a letter to Porsche staff seen by Reuters.

Some analysts question whether he is the right man for the job, given his more than three decades at the company.

"He has made a career within the VW system, so how could he credibly argue that all will change to the better now?" said Commerzbank's Sascha Gommel.

At 1555 GMT, Volkswagen shares were down 7.5 percent at 99.3 euros.

Manufacturers globally now fear more costly regulations and a drop in diesel car sales.

Diesel engines use less fuel and emit less carbon -- blamed for global warming -- than standard gasoline engines. But they emit higher levels of toxic nitrogen oxides, linked to deaths from lung and heart disease.

In most of the world, diesel engines in passenger cars are a niche product. But their fuel economy and low carbon emissions have made them popular in Europe, where they account for half of vehicles sold.