South Korean authorities are continuing a high-profile investigation into Lone Star, the Dallas-based private-equity fund, fueling a public backlash against excessive profits made by foreign investment funds.
Just eight years ago, Lone Star was hailed as a savior, pouring money into companies crippled by South Korea's financial crisis. Today, it appears to be in danger of being run out of town in a flap that could threaten Seoul's attractiveness to foreign investors.
South Korea is investigating Lone Star for possible wrongdoing involving its takeover of Korea Exchange Bank. Lone Star's plan to sell the bank, earning a windfall profit of $4.4 billion, has provoked a public outcry, along with its attempts to avoid Korean taxes.
A separate investigation into allegations of embezzlement and bribery resulted in a raid on Lone Star's Seoul offices and the arrest of three businessmen linked to the fund.
Lone Star's troubles sit at the center of a growing uproar over the huge and often tax-free profits earned by foreign hedge funds and other investment funds, which like Lone Star are now cashing out of lucrative investments made here during and after the financial crisis. Most experts, however, describe the outcry as just growing pains of this country's rapid transformation into one of Asia's most open economies.
"Lone Star was a shock to the system," said Kim Joon Gi, a professor of law at Yonsei University in Seoul. "Koreans were suddenly asking: How on earth could they make such a killing, and then not pay taxes? And to make it worse, they're foreigners."
Behind the uproar is also a sense among many Koreans that foreign investors were given unfairly generous terms after the 1998 financial crisis. They point in particular to the attempts by Lone Star to shelter its profit, the largest ever on a single deal by a foreign investor, from Korean taxes by using international treaties originally designed to prevent double taxation of companies doing business overseas.
[On June 19, government auditors cleared Lone Star of wrongdoing in its 2003 purchase of Korea Exchange Bank, but prosecutors are still investigating, and tax authorities are examining whether they can tax the fund's earnings. And on Friday, a former executive of Korea Exchange Bank received a one-year prison sentence for bribery.]
While Lone Star has received the most attention, other funds have also come under intense scrutiny.
In April, prosecutors indicted the local head of the United States private equity firm Warburg Pincus on insider trading charges stemming from the 2003 purchase of LG Card, a credit card company. Newbridge Capital, another American investment fund, was investigated last year by tax authorities after avoiding taxes on its $1.2 billion in profit from the sale of Korea First Bank.
The American private equity firm Carlyle Group was criticized for not paying taxes on its $740 million profit from the sale of KorAm Bank two years ago. More recently, Carl C. Icahn and another United States investment fund, Steel Partners II, have drawn criticism for trying to take over KT&G, a former state-owned tobacco company.
Some politicians and newspaper editorials have chimed in, calling these investors "vulture funds." Tax officials have announced a sweeping inspection of 6,100 foreign-invested companies and foreign corporate offices in South Korea. In April, South Korea's president, Roh Moo Hyun, even weighed in, saying that deregulation had exposed the country to foreign takeovers.
South Koreais not alone in criticizing investment funds, as the United States Congress has also looked into regulating the hedge fund industry. But South Korea's outrage has been severe, partly due to a deep-seated distaste for excessive profits. The size and intensity of the fury has raised alarms among some overseas investors that a broader nationalist backlash could threaten one of Asia's most dynamic success stories, and the government's proclaimed dream of turning Seoul into a regional financial hub similar to Hong Kong.
A few analysts have also expressed concern that the flap could even escalate into a political dispute between Seoul and Washington, just as they have begun negotiations for a bilateral free trade agreement.
Lone Star's founder and managing partner, John Grayken, summed up the bitterness of some investors in a press conference last month in New York - a rare airing of grievances by one of the normally secretive investment funds.
"The hostile antiforeign investor climate has created great uncertainty for us as investors in Korea," Mr. Grayken told reporters. "It is difficult to manage Lone Star's other investments and determine our future investment policy there."
But most economists, investors and government officials say South Korea is far from closing the doors to its vibrant economy, the world's 10th-largest according to the International Monetary Fund.
These experts say that the shock therapy of throwing open the nation's long-protected economy after the banking and currency crisis of eight years ago has made South Korea a popular destination for direct foreign investment. Last year, it lured $9.6 billion, according to the Korea Trade-Investment Promotion Agency. That's 1.2 percent of South Korea's $800 billion gross domestic product, about 60 percent more on a percentage basis than the United States received from abroad in 2004, the most recent year for which data are available.
"South Korea is still steaming toward globalization," said Moon Hwy Chang, a professor of international business at Seoul National University. "There's been an overreaction to Lone Star, but most Koreans also know we need trade and investment."
Mr. Moon and other experts and officials also point out that about half of that investment comes from industrial companies like General Electric, Motorola and General Motors, which have not been caught up in the current furor. In fact, G.M., which bought the ailing automaker Daewoo Motor four years ago, has even won the grudging respect of labor unions by hiring back 1,600 workers laid off before the takeover.
Rather, these experts say, the investment funds are running into troubles that are at least partly of their own making. Lone Star says it does not owe Korean taxes because Korea Exchange Bank was purchased by the fund's subsidiary in Belgium, a country with which South Korea has a treaty that alleviates its tax burden to Seoul. Lone Star said it would pay taxes on the sale in Belgium, where the rates are lower than those in South Korea. Carlyle did something similar with its sale of KorAm Bank, using a subsidiary in Malaysia, another treaty country.
While legal, such maneuverings have left a bitter taste in the mouths of many Koreans, who see the funds as taking advantage of their country while it was down, and now trying to escape with the loot. "Lone Star Wants to Eat and Run," said a headline in January in The Seoul Shinmun, a major daily. Spurred by public indignation, Korean lawmakers passed a bill last month limiting use of tax treaties.
But the real danger, say some economists, is that public resentment could trigger a broader backlash that could sour interest among foreign investors. While this remains unlikely, they say there are widespread misgivings with the rapid pace of South Korea's opening to the world after the 1998 crisis.
"Korea is in a delicate period, a transition period to becoming more global," said Mr. Moon of Seoul National University. "Those opposed to globalization are seizing upon the mistakes of Lone Star and other funds to say slow down."
The Korean government has found itself caught in the middle, reassuring overseas investors while also trying to appease domestic anger. But they insist that the country remains open to investment.
"Korea's policy of attracting foreign capital is unchanged," the commerce minister, Chung Sye Kyun, said in an interview. "I will personally lead the charge to protect any businesses, foreign or domestic, from unfair or discriminatory actions."
For their part, investment funds say they are entitled to the large windfalls because they took such huge risks, buying bankrupt and ailing companies at a time when no one else had the money or the appetite to invest. But in an apparent recognition that it may have gone too far, Lone Star said in April that it would donate $104 million to Korean charities, and keep $763 million in a bank account in South Korea to cover any taxes that it might owe. Mr. Grayken said the fund's current investments in South Korea totaled $5 billion.
Many foreign business leaders in South Korea say the public attention is natural given the problems at Lone Star. And they say the recent uproar over foreign investment is just a hiccup for a country learning to adjust to the rapid opening of its economy since 1998.
"The U.S. went through the same thing in the 1980's with Japan, and more recently with Dubai ports," said Tami Overby, president of the American Chamber of Commerce in Korea, a lobby group for United States businesses. "Korea has taken a huge bite and is still trying to digest it."
- 185 Corruption