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 Korean authorities are investigating Lone Star for possible wrongdoings involving its takeover of a local bank, Korea Exchange Bank. Lone Star's plan to sell the bank, earning a windfall profit of US$4.4 billion, has provoked a public outcry, along with its attempts to avoid South 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 and sophisticated major 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 South 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 South Korean taxes by using international treaties originally designed to prevent double taxation of companies doing business overseas.
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 US 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 US$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 US$740 million profit from the sale of KorAm Bank two years ago. More recently, Carl Icahn and another US investment fund, Steel Partners II, have drawn criticism for trying to take over KT&G, a formerly 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 Korean President Roh Moo-hyun even weighed in, saying that deregulation had exposed the country to foreign takeovers.
While South Korea is not alone in criticizing these types of funds, the country'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 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.
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