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UPDATE 1-EU Commission takes aim at Germany over VW law

(Adds quotes, detail)

By Lisa Jucca

BRUSSELS, March 19 (Reuters) - The European Commission defied Germany on Wednesday by starting legal action against a law that shields Europe's largest carmarker, Volkswagen AG , from a hostile takeover.

The move risks a clash with German Chancellor Gerhard Schroeder, who has defended the VW law which could give the state of Lower Saxony, where Schroeder used to be prime minister, a blocking minority by capping shareholder voting rights at 20 percent.

"The Commission is concerned that certain provisions of that law could act as a disincentive on investment from other member states in violation of EC treaty rules on the free movement of capital and the right of establishment," the Commission said.

VW shares were trading 2.6 percent higher at 33.37 euros by 1157 GMT. The company had no immediate comment on the Commission's decision, but Chief Executive Bernd Pischetsrieder has said the law is no barrier to a takeover.

The decision, the first step in legal action that may end up in court, is part of a Commission drive to remove obstacles to investment in the 15-nation bloc and boost economic growth, an issue EU leaders will address at a summit this week.

The EU executive had postponed its move by two weeks after Internal Markets Commissioner Bolkestein failed to convince fellow commissioners that the politically sensitive law violated fundamental EU rights.

Schroeder has in the past accused Bolkestein of deliberately taking aim at German industry, as with a planned EU code to ease cross-border takeovers seen as making German firms vulnerable.

Germany has two months to respond in detail to Commission objections to the law or face further legal action.

BARRIER TO INVESTMENT

Analysts say the VW law is aimed at safeguarding more than 150,000 jobs in Europe's biggest economy and making sure the manufacturer does not fall under the control of a foreign rival.

It also allows Lower Saxony, which holds just under 20 percent of VW's common stock, to appoint members of the supervisory board.

The Commission is concerned that the law means that shareholders, regardless of the number of shares they hold, can only cast a maximum of 20 percent of the votes at a shareholder meeting. In combination with this, a majority of over 80 percent of the votes is required to approve important decisions.

The law also says the German federal government and Lower Saxony, where VW is based, should each have two seats on the supervisory board. The board consists of 20 members, 10 representing shareholders and 10 representing VW employees.

Since the federal state has sold all its shares, Lower Saxony is now the only party entitled to delegate two members to the supervisory board, the Commission said. Analysts said a change in the law could modify investors' perception of the company and make its shares more attractive.

Pischetsrieder earlier this month defended the law.

"If someone wants to take over VW they can do so with or without the law. If Mr. Bolkestein wants to acquire 20 percent of VW he can do so," he said.