SEOUL, South Korea — Lone Star Funds, a Dallas-based private-equity firm, made big money in South Korea by investing billions of dollars in struggling businesses and other assets in the aftermath of the 1997-98 Asian financial crisis.Now it’s in big trouble. Prosecutors have been investigating its investments for nine months, and on Monday they indicted the firm on charges of stock-price manipulation.

The probe comes during a backlash in Asia against overseas investors, fuelling accusations that prosecutors targeted Lone Star to curry favour with politicians and others who view such firms as profiteering interlopers, enriching themselves at the expense of locals. Such nationalistic sentiments are especially acute here.

“We are very concerned about foreign investment in Korea,” says Mark Mobius, who oversees emerging-markets portfolios at US money manager Franklin Templeton Investments. “People should start to speak out, because we are all at risk.”

Prosecutors dismiss any suggestion that the probe is part of a backlash against overseas investors. Chae Dong Wook, the case’s chief prosecutor, has repeatedly said there is “no political motivation”.

The indictment charges Lone Star and Korea Exchange Bank, which the firm bought control of three years ago, with driving down the stock of the bank’s credit-card unit so they could buy out that unit’s minority shareholders at a lower price. Lone Star and KEB deny the charges. (Shares of KEB itself have risen since Lone Star bought its stake.)

Though Lone Star has made plenty of money on other Korean investments, the inquiry has delayed its efforts to make a profit of roughly $4.5 billion from the sale of its KEB stake, which Korea’s Kookmin Bank agreed to buy in May for more than $7 billion. Lone Star is considering killing the deal because it feels KEB has gotten more valuable since it struck the deal with Kookmin.

“The principal reason for this investigation is the political backlash as a result of the gain we stand to make on the investment,” says John Grayken, Lone Star’s founder. “We would not have this problem if we were making a 10 percent profit.”

There is no denying the anger here over profits foreign investors have reaped selling assets acquired at fire-sale prices after the Asian crisis. The outrage has focused on the use of shelters by Lone Star and others to avoid capital-gains taxes in both Korea and the US, where many private-equity funds are based.

Wariness of foreign investors also is evident elsewhere. China has blocked several acquisitions, including Carlyle Group’s attempt to buy 85 percent of construction-equipment maker Xugong Group; the Washington-based private-equity firm now is angling for a much smaller stake. China also has set a 25 percent cap on foreign ownership of banks, thwarting Citigroup Inc.’s desire for a larger stake in Guangdong Development Bank.

Government and business here erected protectionist barriers to foster domestic economic growth in the decades after the Korean War. Now the world’s 10th-largest economy is moving toward a more open market, but protectionist sentiment remains, even as some Korean business leaders express concern over the treatment of Lone Star and other foreign investors.

Such feelings have prompted some private-equity funds to change how they operate. Newbridge Capital Ltd., based in Forth Worth, Texas, no longer has a senior partner here and hasn’t done any new deals in the country since selling its stake in Korea First Bank in 2005 for nearly triple its 1999 outlay. The Carlyle Group recently registered its Korean investments in the US, to fulfill a pledge to subject itself to U.S. tax laws. Both firms declined to comment.

Overseas investors say the backlash is holding up deals here. Despite a flood of private-equity money into Asia, foreign-led buyouts in Korea, by dollar value, have plunged 85 percent this year, says Asian Venture Capital Journal.

Lone Star’s troubles here extend beyond KEB’s credit-card unit. Prosecutors are continuing to probe the purchase of the bank itself in 2003, and tax authorities are demanding large levies on profits from the sale of a Seoul office tower in 2004, as well as money Lone Star made investing billions of dollars in distressed loans after the Asian financial crisis.

The criminal investigation has resulted in a cavalcade of arrest warrants and detentions of foreigners and locals who worked on the KEB deal. The central question is whether the firm conspired with bank and government officials to make the bank’s books look like KEB was in worse financial shape than it actually was. Korean lawmakers argue that the purchase price — 13 percent more than the trading price of the bank’s shares at the time — was too cheap. Some lawmakers have threatened to nullify the purchase, though that seems unlikely.

At the time of the sale, Korea’s largest banks were grappling with mounds of bad debt that resulted from an easy credit policy aimed at spurring consumers to use credit cards to drive growth in the aftermath of the financial crisis. KEB needed capital to tide it over, so it turned to Lone Star, which specialises in buying up troubled assets on the cheap and improving them with an eye toward a profitable resale.

Mr. Grayken, who started Lone Star in 1995, was a protege of the Bass brothers, the Texas billionaires, and had cut his teeth resolving bad debt during the US savings-and-loan meltdown in the late 1980s. He sought to apply the same principles in Asia. The firm poured more than $5 billion into Korea, becoming its biggest foreign investor.

At KEB, Lone Star installed Robert Fallon, a former head of global financial services at J.P. Morgan Chase, as chief executive and Richard Wacker, a former executive at General Electric Co.’s financial subsidiary, GE Capital Services, as chief operating officer. Messrs. Fallon and Wacker moved to revive the bank’s finances, cutting 400 jobs, closing low-traffic branches, trimming other expenses, implementing rigorous credit-risk analysis and updating technology.

In 2005, after Mr. Wacker succeeded Mr. Fallon as CEO, a managing director who had supported Lone Star’s bid to buy the bank was caught installing hidden cameras in the chief’s office. KEB dismissed the director, Jeon Young Jun, who has filed a lawsuit in Korea for wrongful termination. He couldn’t be reached for comment. Mr. Wacker declined to comment.

The Lone Star team’s efforts seemed to work. The first quarter of 2005, KEB’s net income more than doubled to 325.8 billion won ($348.3 million) from the previous quarter, the bank says in financial statements. Lone Star figured the time was ripe to harvest its gains — just as the government’s National Tax Service brought a disturbing revelation to the firm’s attention. During a routine audit of several foreign funds, the tax authorities found suspicious invoices filed by Lone Star’s former top executive in South Korea, Steven Lee.

Mr. Lee, a Korean-American and graduate of Harvard Business School, had moved to Seoul in 1998 from Dallas to oversee Lone Star’s investments here. Mr. Lee garnered a reputation for spotting lucrative deals. In the spring of 2005, he resigned and moved to Short Hills, New Jersey. Former colleagues say he told them he was “fatigued”.

Upon looking into the matter, Lone Star discovered that Mr. Lee had submitted dozens of phoney invoices during his seven years in Korea, diverting about $12 million to pay for property, works of art and cash gifts to family members. Mr. Lee’s Newark, New Jersey, lawyer, Larry Lustberg, says his client’s actions were “stupid” and that Mr. Lee has repaid all the funds. The revelations prompted regulators to open an inquiry into the firm, which led to areas far removed from the theft.

In the case involving the credit-card unit, KEB announced a plan to rescue KEB Credit Services in November, 2003, after Lone Star had bought the bank. Under the plan, the bank would have negotiated with the unit’s creditors, while leaving its shareholders with nothing. The unit’s share price tanked as investors rushed to sell. Days later, KEB changed course, moving to buy out unit’s minority investors, whose shares were now worth much less. Prosecutors estimate that the decline cost minority shareholders about 22.6 billion won.

“Steven Lee’s embezzlement clearly inflamed the situation and made things more difficult for us,” Lone Star’s Mr. Grayken says. The firm has filed a lawsuit in Bermuda against Mr. Lee to void his claim on profits from the KEB sale, which could have been as much as $50 million, people familiar with such transactions say. Mr. Lustberg, the Lee lawyer, has said his client will fight the suit.

The routine audit, meanwhile, resulted in a 140 billion won assessment for back taxes related to Lone Star’s sale of the Star Tower office building in Seoul. The firm is fighting the assessment.

To address criticism that it was trying to evade taxes, the firm set aside about $700 million in a Korean bank until the KEB tax dispute is resolved.

Critics see Lone Star’s tax woes as part of a bigger problem involving foreign private-equity funds.

“They didn’t abuse (tax laws) more than the others,” says Sim Sang Jeong, a lawmaker with Korea’s opposition Democratic Labor Party.