Rupert Stadler, 55, is the highest ranking Volkswagen executive to be arrested in connection to a costly diesel emissions scandal that burst into public view in 2015.
Volkswagen spokesman Nicolai Laude confirmed that Stadler had been arrested, but declined to comment on the investigation.
Prosecutors said they had opened a criminal investigation into potential fraud by 20 current or former Audi employees including Stadler. The case is related to suspected emissions cheating in 240,000 diesel cars sold in the United States and Europe.
The arrest comes just days after Germany imposed a €1 billion (£876 million) penalty on Volkswagen for rigging diesel engine emissions worldwide.
Volkswagen has admitted that it rigged millions of diesel engines to cheat on emissions tests.
Diesel cars from Volkswagen and its Audi subsidiary cheated on clean air rules with software that made emissions look less toxic than they actually were.
The scandal sent the share price in Volkswagen down by 3% in Frankfurt and trashed confidence among consumer and regulators in diesel technology. The episode has already cost Volkswagen over £22 billion in recalls, legal penalties and settlements.
Prosecutors said on Monday that Rupert Stadler, who has worked for Audi parent company Volkswagen since 1990, had been detained because of concerns he could influence witnesses in an ongoing fraud investigation.
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