Samsung Under Siege

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Samsung's theme park, Everland plays a central role in family control Ahn Young-Joon/AP Photo

An anti-Samsung protester in Seoul wears a mask of chairman Lee Lee Jin-Man/AP Photo

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Instead, he summons top executives to weekly briefings at his posh residential compound in Hannamdong, a Seoul district popular among diplomats and foreign bankers. When Lee engages, former group executives say, he can be intense and incredibly focused, sometimes conducting all-night meetings.

Lee is especially involved with the nitty-gritty details of Samsung's gadgets. He presides over annual quality meetings comparing Samsung phones, TVs, and washing machines to those of key rivals. And in 1991 he bought a Japanese videocassette recorder in Los Angeles and disassembled it himself in his hotel room. He calculated that parts used in a similar Samsung VCR cost 20% more. He ordered staff to slash the number of parts to lower costs, which they did. "Chairman Lee certainly deserves credit for making Samsung a global brand," says a former manager.

SECRETIVE CIRCLE

But Lee seems to have been equally obsessed with family control. The linchpin of the Samsung group is the Strategic Planning Office, a secretive unit that is headed by Lee Hak Soo (no relation to the chairman), the second-ranking executive in the conglomerate. The SPO, which the chairman once described as Samsung's "control tower," occupies two floors right below Lee's penthouse suite at Seoul headquarters. All 99 SPO staff are technically employees of Samsung affiliates, which pays their salaries, but in Korea they're known as the Lees' gashin, or butlers. "Putting on the chairman's coat of armor, they monopolize power as far as finance, personnel, and auditing are concerned," says a retired executive who spoke on condition of anonymity. A spokesman for the SPO declined interview requests, but in written answers to questions denied that the office promotes family interests. "The SPO's role is to boost Samsung companies' competitiveness and synergies," the official said.

The traditional purpose of the SPO, which has counterparts in other chaebol, is to provide strategic vision, administrative support, and financial muscle for affiliates. Such a structure made sense in the early days of industrialization, "when Korea lacked sophisticated markets for capital and talent," says Korean National Open University economist Kim Ki Won, who has studied the chaebol for two decades. "But with those markets in place now, its negative side effects far outweigh its contributions." What's more, contends Hansung University economist Kim Sang Jo, head of the Solidarity for Economic Reform shareholder rights group, the SPO isn't accountable to investors because it isn't even a legal entity. "There's no legal way to hold it responsible even if it makes serious blunders," he says.

WINDFALL PROFITS?

One of the most controversial moves was a 1996 deal allegedly arranged by the SPO that gave the Lee family an outsize stake in Everland. Lee Jae Yong and his three sisters paid $9.9 million to exercise warrants converting bonds they held into shares of the unlisted amusement park and real estate company. After doing so, the children ended up with 64% of Everland. Korean prosecutors asserted that the Lees paid roughly $8 apiece for shares that were worth more than 11 times that. Then, in a private placement, Everland allegedly was able to buy 18.4% of shares in unlisted Samsung Life that had once belonged to the founder but had been transferred into accounts controlled by Samsung executives. Samsung Life, in turn, owns 7.3% of Samsung Electronics. So by controlling Everland, Lee Jae Yong now controls the biggest block of shares in the electronics giant. In a parliamentary hearing, Korean lawmakers estimated the Lees acquired the Samsung Life shares for less than 2% of their fair market value.

In 2005, a Seoul court found two Samsung Everland executives guilty of betraying their fiduciary responsibilities for allowing the bond deal to go through. They were given suspended sentences of three years. But the court did not unwind the stock and bond transactions on the grounds that it had no authority to do so. No shareholder lawsuits were filed. Everland's other investors were either companies controlled by Lee relatives or Samsung affiliates. The SPO declined comment on the share transactions.

Lee Jae Yong is accused of making windfall profits from other deals as well. A Korean civic group, People's Solidarity for Participatory Democracy, cites tax records showing that the younger Lee in 1995 paid $4.6 million for stock in unlisted Samsung Group companies, such as factory builder Samsung Engineering and security specialist S1. Over the next two years, according to securities filings, he sold those shares for a $62 million profit when those companies floated their shares on the stock market. People's Solidarity contends the SPO must have known the companies were about to go public and that Lee Jae Yong underpaid. Samsung declined to comment.

In a nation accustomed to sensational scandals involving the chaebol, few believe the current Samsung case will do much to improve corporate governance in Korea. In the past, charges against tycoons have been dropped after they made large charitable donations. In 2005, Lee Kun Hee left the country for five months for what Samsung described as health reasons while he was under investigation for allegedly making big illegal donations in 1997 to presidential candidates. The probe was dropped, but when Lee arrived back in Korea he publicly apologized—and donated $825 million to charity.

Given the conglomerate's overwhelming dominance of the nation's business scene today, the Samsung case is viewed as a pivotal test of Korea's ability to establish a more solid rule of law. Until Seoul manages to clear up the murky structures of the chaebol, it will be hard for listed companies they control to shake worries about the companies' independence. "Samsung simply doesn't have a system where the controlling shareholder's management can be checked and monitored," says Korea University corporate governance expert Park Kyung Suh. "Such a system can't be sustainable."

With Pete Engardio in New York

Moon is BusinessWeek's Seoul bureau chief.