SEOUL (Bloomberg-Wall Street Journal) ? Lone Star Funds, the biggest overseas investor in South Korea, said it broke tax laws after the firm?s former country head embezzled $12 million.

Steven Lee, who ran the fund?s operations in Seoul from 1998 until last year, confessed in a signed document, Lone Star founder John Grayken told a briefing in the city yesterday. Lee, 37, is being investigated, and the leveraged-buyout firm may press charges, he said. Lee, who has left Korea, wasn?t available to comment and calls to his lawyer went unanswered.

Lone Star has filed a civil suit against Lee in the Bermuda Supreme Court, where several of its funds are based. The suit seeks to nullify his financial stake in Lone Star, which would keep him from sharing the profits from the $6.6 billion sale of Korea Exchange Bank to Kookmin Bank, the nation?s largest lender.

Lawrence Lustberg, Lee?s attorney, told the Wall Street Journal that he and his client haven?t been summoned to appear in the Bermuda Supreme Court and ?will vigorously contest? any attempt to void Lee?s share of KEB profits. Korean prosecutors and tax authorities are investigating Dallas-based Lone Star, delaying the $6.6 billion sale of KEB to Kookmin Bank. The case may deter overseas investment in South Korea, where executives at Dubai-based hedge fund Sovereign Global Investment Ltd. were threatened with prosecution for securities violation over their attempts to oust the management at SK Corp. in 2003.

?If it takes a long time to finish this case, it?s not encouraging foreign investment in Korea,? said Hank Morris, a director at Industrial Research and Consulting in Seoul. ?Laws and regulations are not often completely clear. Sometimes, they are a contradiction. So, it causes confusion.?

The sale will make more than $4 billion for Lone Star and its investors, which include the New York State Teachers? Retirement System and the Oregon Investment Council.

Grayken said Lone Star paid 165 billion won ($175 million) in taxes on its investments in South Korea, and the fund adheres to tax rules in all countries where it operates.

South Korean prosecutors last month issued a warrant to detain Steven Lee. The prosecutors also raided the homes of the heads of Lone Star Advisers Korea and Hudson Advisers Korea, local units of Lone Star Funds.

Investigators are probing whether government and former Korea Exchange officials deliberately under-reported Korea Exchange?s Bank for International Settlements ratio to allow Lone Star to acquire the stake.

Grayken said the fund wasn?t involved in the calculation of Korea Exchange?s BIS ratio before its 2003 takeover. He said the fund had always planned to sell its stake to an industry buyer so wasn?t rushing the sale.

Korea?s Financial Supervisory Service in February ordered Lone Star to improve its operations after the financial watchdog said the US firm breached rules regarding asset-backed securities and foreign-exchange transactions.

Hudson Advisers and Lone Star Advisers should return service charges paid through six transactions to overseas residents, the Financial Supervisory Service said. The units were ordered to reinforce internal monitoring systems in compliance with Korean regulations on the operation of special purpose ventures for asset-backed securities, the regulator said. They will be also banned for one year from paying service charges to overseas residents.

It?s the first time the Korean regulator had made a ?corrective order? on an overseas entity for breaching rules on asset-backed securitisation.

Sovereign in July ended a two-year attempt to oust Chey Tae Won, Chairman of SK Corp., South Korea?s biggest oil refiner. The fund, then know as Sovereign Asset Management, built up a 14.99 percent stake in the company in 2003. It wanted Chey to step down after he was convicted of a $1.5 billion fraud.

The Korean Ministry of Commerce, Industry and Energy said at the time that Sovereign may face penalties for failing to give prior notice to the government that it planned to accumulate a ten percent stake in SK Corp.