Texas firm, indicted in Seoul, ends bank deal

Returning a South Korean bank to South Korean ownership after three years in foreign hands might normally be a transaction of national pride.

But for the last eight months, South Korea has been riveted by a rancorous and highly public criminal investigation into the proposed sale of Korea Exchange Bank by Lone Star Funds, a Dallas-based private equity firm.

Enraged in part by the $4-billion profit Lone Star hopes to reap from the deal, South Korean prosecutors this week indicted Lone Star on charges of stock manipulation stemming from its purchase of the floundering Korea Exchange three years ago.

The investigation prompted Lone Star on Thursday to terminate a $7.4-billion agreement to sell Korea Exchange to South Korea’s largest bank, Kookmin Bank.

“We have concluded that we cannot move forward ... due to the continuing investigations surrounding Lone Star’s investment,” Lone Star Chairman John Grayken said.

In addition to scuttling Lone Star’s deal, the increasingly messy case has become a wider test of whether Asia’s third-biggest economy is as open to foreign investors as its government claims.

“There is great concern about the way the case is being handled and it’s making foreign investors uneasy,” said Kim Kihwan, an international investment advisor at Goldman Sachs in Seoul. “Investors may get the idea that the rule of law and due process is not established in Korea.”

Among the worries is the way in which investigators from the Supreme Prosecutors’ Office have fed a steady stream of insinuations about corporate malfeasance to the Korean media, stoking nationalist resentment against foreign investors. Critics accuse the prosecutors of harboring a grudge against foreign private equity firms, which came to South Korea and swept up cheap assets in the wake of the Asian financial crisis of 1997.

The prosecutors reply that their focus is Lone Star, and that they have evidence that the 2003 sale broke Korean law. Lone Star bought a controlling stake in Korea Exchange for 1.4 trillion won, or $1.5 billion.

Nervousness has intensified since arrest warrants were issued last week against Ellis Short, Lone Star’s co-founder, and Michael Thomson, its general counsel, on stock manipulation charges. The company has said its executives will not travel to South Korea for questioning without guarantees of being able to leave. Prosecutors have vowed to use Seoul’s extradition treaty with the U.S. to bring them here.

But many here say that whether guilt is proven or not, the “Lone Star effect” has already smeared South Korea’s image as a welcoming place for foreign capital. They claim it has scuttled or postponed other investments into South Korea, contributing to this year’s drop in direct foreign investment.

“It’s having a real impact on potential deals that are not being done,” said Tami Overby, president of the American Chamber of Commerce in South Korea. “Investors want predictability and consistency.”

She called the prosecutors’ handling of the case “out of the ordinary” and noted that in 19 years in South Korea she has never seen a case generate such intense media coverage.

Hostility to Lone Star was not evident when the private equity firm stepped in to buy Korea Exchange, the nation’s fourth-largest bank. It was then sinking under portfolios of bad loans. Lone Star took a controlling stake and watched the value of its investment soar as Korea’s robust economic growth resumed.

In March, Lone Star -- never planning to run a bank for the long haul -- chose to cash out and struck a deal to sell to Kookmin.

But it was held up almost from the start. Prosecutors first investigated whether Lone Star and Korea Exchange executives conspired with government officials in 2003 to make the bank’s books appear worse than they were. The aim, prosecutors say, was to meet legal benchmarks of financial distress that would make the bank eligible for sale to a foreign company.

A state audit cleared Lone Star of that accusation, but prosecutors have continued to pursue leads they claim show a conspiracy. And they subsequently alleged that Lone Star executives spread false rumors to artificially lower the share price of KEB Card, the bank’s credit card subsidiary, before buying it.

Many here argue that prosecutors are grandstanding to a current of economic nationalism. There is some public unease here at the increasing American-style management of local companies, which critics blame on increased foreign ownership of the country’s economy.

“It is not generally accepted here that profits are a result of taking a risk,” said Kim Sanjo, a professor of economics at Hansung University in Seoul. “Koreans hate these profits, and Lone Star made a great amount of money from the KEB deal, so there is suspicion that they did something wrong.

“But this will cause a deepening of the Korean discount among foreign investors. They will say, ‘Even if we make money in Korea, we cannot get our money out of Korea.’ ”

Prosecutors were initially unable to get Korean courts to agree to issue warrants to arrest Lone Star executives; only after resubmitting applications several times did they finally succeed. They also publicly challenged the integrity of the judges hearing the case.

Their vitriol reached new heights this week when prosecutors accused Supreme Court Chief Justice Lee Yong-hun of encouraging lower court judges to take a soft approach with Lone Star because he once represented the American company in other litigation.

“It’s not so much a matter of Korean nationalism anymore, though it may have begun that way,” Goldman’s Kim said. “Now it’s a fight between the enforcement agency and the courts. The prosecutors just do not want to give up.”

And in the minds of some, that persistence -- and, so far, the lack of public evidence -- raises the specter of a campaign against foreign companies that undercuts the government’s official message that South Korea is eager for more direct foreign investment.

“This has been very discouraging to those of us who have sought to promote Korea to the rest of the world,” said James Rooney, chief executive of Market Place, an investment consulting firm in Seoul. “It is one of the worst PR events Korea could come up with.

“All we can hope for is that it proves to be cathartic; that having gone through this experience once, the Koreans will never want to repeat it.”

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bruce.wallace@latimes.com

The Associated Press and Bloomberg News were used in compiling this report.