Lone Star’s Korea crisis

Between 1998 and 2003, Texas-based Lone Star Funds did roughly 50 private equity deals in Korea.  It had forged professional relationships with Korea’s regulators and financial houses and was well known to the local business community. It was, to say the least, a familiar face.

Yet when it bought Korea Exchange Bank August 2003, it became the focal point for public anger. Nine years later (see below), after several scrapped exit attempts, raids on its local office, a jailed employee and an increasingly adversarial relationship with the Korean government Lone Star was found guilty of stock price manipulation in October 2011. The firm decided not to appeal, instead selling KEB to Hana Financial Group in February.

Shortly after the exit, Lone Star again came under fire. In April, the Oregon Public Employees Retirement Fund, an LP, filed a lawsuit alleging that the firm failed to fully inform the investment council of the truth behind what was taking place in Korea.

The following month, Lone Star filed an international arbitration claim against the South Korean government – the country’s first – claiming it had suffered billions of euros in damages as a result of what it characterised as “arbitrary and discriminatory conduct” on the part of regulators and “unlawful interference with Lone Star’s rights” as KEB’s major shareholder. The case is scheduled to start in November.


KEB should have been like any other investment. Lone Star argues that it only did what private equity normally tries to do: it took something in bad shape, made it better and reaped a profit for doing so. In fact, a data-backed case study in 2007 (Menke and Schiereck) found that “a significant portion of KEB’s performance can be attributed to Lone Star”.

However, there were other complicating factors over and above performance. The deal happened in the wake of the Asian crisis, when many Koreans were critical of foreign intervention (like that of the IMF) in their economy; KEB was a distressed, partially state-owned bank that started firing employees after Lone Star bought it; the investment came through a Korean-Belgium treaty that eliminated capital gains tax.
But there were also two specific events that proved to be significant.

The first was the formation of SpecWatch by a former KEB union employee. This civic action group, which was set up just after Lone Star acquired KEB, organised street protests and pressured the government to look into the KEB acquisition, insisting that it was done illegally.

“SpecWatch was very effective in stirring up grassroots political sentiment against that acquisition,” says a source close to the KEB deal. Pressure mounted on regulators to do something. The problem was, authorities had no verifiable evidence to take decisive action. But that changed with the second pivotal events in 2006: Lone Star fired Steven Lee, the head of its Korea operations, for misappropriation of funds.Lee’s actions were unconnected to the KEB allegations, but in some quarters, it seemed to chime perfectly with previous suspicions.“Steven Lee had traceable illegal activity,” says a local source close the matter. “This was a turning point because now public prosecutors had something tangible to go on and [their efforts] were backed by public sentiment. It became political.”

A foreign industry source close to the matter added: “In this setting, [Steven Lee] was a catalyst for saying ‘These guys are crooks. They must have done something unlawful to get the bank so cheaply. They can’t make this much money naturally on this bank.’ That gave a platform for prosecutors and politicians to say, ‘Now why can’t we do something to stop the sale or take it back or do something?’ It just blew up.”
At the same time, The Carlyle Group and Newbridge Capital were selling Korean assets for large profits and Koreans labeled private equity as “vultures” that “eat and run”, stripping national assets and disappearing.

So why was Lone Star specifically singled out? It depends who you talk to.
The Korean side believes Lone Star was simply guilty of acquiring KEB at an illegally discounted price – a view apparently legitimised by the 2011 conviction of Lone Star by a Seoul court. Lone Star’s position that the charges against it stemmed from Korean nationalism was “more of a PR tactic than a reality”, says one local industry source.

Another view, from a Korean source who had some involvement with KEB, says Lone Star riled the public in the way it handled the situation. Co-founder John Grayken did speak out occasionally during the nine-year saga, and he flew to Seoul to defend another employee, Paul Yoo, against charges of stock price manipulation.
But there’s a cultural dimension to crisis response. The firm’s consistent headline message was that Lone Star did nothing wrong. That resonates better in the US than in Korea, where this kind of flat denial can be viewed as arrogance.

“You can’t go it alone in Korea and expect to win if you don’t combat negative public sentiment [correctly],” says the source. “Lone Star did not have the best public relations strategy. The lesson is: you have to appear to be humble in Korea if you are making money.”

Lone Star itself, according to a source with knowledge of the matter, takes a different view. The deal blew up because “there are points at which the law doesn’t matter [in Korea]. It doesn’t happen to all, by any stretch. But be very careful investing in that environment, because of the risk in a shift in public sentiment. It’s totally unpredictable, so investors can’t protect against it.”

Equally, it’s possible that Lone Star’s KEB ordeal was just an anomaly – a confluence of bad timing (post-crisis), bad luck (Steven Lee’s firing) and PR missteps. After all, foreign private equity firms continue to do business in Korea – Headland Capital Partners, Affinity Equity Partners and Morgan Stanley Private Equity among them.
Either way, the saga will continue for a while yet. International arbitration requires a six-month ‘cooling-off period’, which ends in November; after this, the full process could take up to two years, according to Jaemin Lee, professor of law at Hanyang University (the two sides could still hammer out a deal, even after the proceedings start, but sources suggest this is highly unlikely).

Then again, once the decision has been made, Lone Star has no right of appeal. Although at this stage, perhaps it will be grateful just to move on, whatever the outcome. ?