(FORTUNE Magazine) - For the past three years, South Korea's Hyundai Motor has been the fastest-growing automaker on the planet. Driven by increased sales in the U.S., China, and India--not to mention in its home country--it has boosted production by a third and is poised to pass DaimlerChrysler and join the ranks of the world's top five auto manufacturers. Unit sales were up 16% in the first quarter, leaving industry observers wondering whether anything could slow the company's growth.
Now the answer to that question has become clear: Hyundai itself. Both the chairman of Hyundai Motor, Chung Mong-koo, 68, and his son, Kia Motors president Chung Eui-sun, 36, are under investigation for their roles in scandals involving political slush funds and the misuse of company money through self-dealing. In late April the elder Chung was arrested and charged with embezzling $106 million from the company to create slush funds and misappropriating another $318 million. Prosecutors are also trying to figure out what charges to bring against ten other Hyundai executives, including the younger Chung.
The affair has cast a pall over the company and the Chung family, which founded Hyundai nearly 60 years ago. Kia, a sister company, was forced to postpone an April groundbreaking ceremony in Georgia for its first American plant because Korean prosecutors barred the younger Chung from leaving the country. The event has been put off indefinitely, but a Kia spokesman says construction of the $1.2 billion plant will go forward. More significant is the possible departure of the elder Chung from the company, at least until his legal problems are resolved. "The ramifications are beyond description," a Hyundai spokesman said.
Hyundai's problems reflect the cozy, insider nature of big business in Korea, where family ties and personal interests often outweigh concern for shareholders. The events in question date back to 2001, when the two Chungs set up a logistics company called Glovis to deliver auto parts and assembled cars. To no one's surprise, the company quickly won lucrative contracts from Hyundai and Kia, and the value of the Chungs' investment skyrocketed from about $5 million to $1 billion. The younger Chung sold some of his shares in Glovis and apparently used the profits to buy a 2% stake in Kia to solidify his position as his father's successor. Holding a significant stake in Kia was important because of the intertwined financial ties among affiliates that allow the Chungs to control Hyundai. Prosecutors want to know if the Chungs transferred corporate assets between themselves illegally.
Authorities have also been questioning other Hyundai executives about allegations of illegal payoffs. The head of Glovis has been charged with creating a $7.2 million political slush fund, and two lobbyists have been arrested for using Hyundai's largess to help the company win approvals for construction projects. If all this sounds familiar, it is: A top Hyundai executive was convicted of delivering cash to a political candidate in 2002.
With charges flying--Hyundai executives are also suspected of embezzlement, tax evasion, misuse of public funds, and illegally transferring stock ownership--the company announced it would make a $1 billion donation to social-welfare programs to atone for illicit activities and restore public confidence. It also apologized for failing to meet its "social obligations" and causing public concern. But the Chungs failed to admit any wrongdoing, and their offer of charity apparently was not enough to deter prosecutors.
The scandals have reawakened concerns about the stability of Hyundai's U.S. management, where officials come and go with alarming speed. Last October, Kia's U.S. CEO, Peter Butterfield, was escorted from a dinner at a dealers' meeting and fired in a nearby room. Hyundai U.S. president Bob Cosmai left his job abruptly in January, apparently because he failed to meet ambitious sales targets.
Now questions are being asked about the impact of the scandal on Hyundai's future. The company's stock price has fallen from $98 at the beginning of the year to $89 as of April 28, and analysts expect first-quarter profits will decline by 7%. Bruce Klingner, an analyst at Eurasia Group, a political-risk consultancy, expects some short-term turbulence, including postponement of globalization plans. But he adds that Hyundai's status as the country's second-largest conglomerate may protect it against long-term disruption for fear that aggressive prosecution might derail South Korea's economy.