Usually, such corporate tie-ups in the semiconductor industry aren't the stuff of police investigations. However, in Taiwan, which is worried about the loss of its core foundry business to political rival China, the government restricts investments in certain technologies there, including semiconductor plants capable of processing integrated circuits on 200-mm diameter and 300-mm diameter wafers.

The government is charging UMC with breach of trust, accusing it of flouting the law by playing a major role in setting up Hejian. The company could face fines of up to $800,000 and its executives could be jailed for up to five years if they are found guilty.

In an open letter to the prosecutor printed in the island's major newspapers, UMC chairman Robert Tsao rebutted allegations that he and UMC illegally invested in Hejian. "I made the decision that we can help the establishment of Hejian, but under the condition that UMC and any individual employee cannot invest in Hejian and we cannot disobey any regulations."

Tsao denied that he or UMC had broken the law, and asked prosecutors to end their investigation. He also tried to cast doubt on the source of a recent tip that spurred the investigation, saying the source is a former employee of Hejian who once worked for competitor Semiconductor Manufacturing International Co and thus had ulterior motives for disrupting the operations of UMC and Hejian.

Tsao also justified the decision to offer guidance to Hejian by saying it was made only after a group of UMC employees, including Hejian chairman Hsu Jien-hwa, had decided to start a foundry in China. Tsao believed helping the company would eventually benefit UMC because it would curb the growth of Shanghai-based SMIC, an emerging rival at the time. He also said Hejian was viewed as a possible acquisition target for UMC after Taiwan eased restrictions on governing technology investment, giving UMC a foothold in the fast-growing China semiconductor market.

Although Hejian started operations just two years ago, and only has capacity for processing about 30,000 wafers a month using 0.15-micron to 0.50-micron manufacturing technology, the company has said it will invest more than $10 billion over the next 10 years to become China's largest foundry.

Tsao acknowledged directing wafer orders to Hejian, but insisted that those clients wanted China-based manufacturing, perhaps to satisfy local content laws in China or to be closer to component suppliers using the chips. Those orders were already "lost" to UMC, Tsao said, so he argued it was better they go to Hejian than SMIC.

The statement was given to newspapers Thursday (Feb. 17), the same day that Hejian Technology chairman Hsu Chien-hwa was released on $315,000 bail. He had been arrested the day before, shortly after authorities raided several UMC offices and the home of UMC vice chairman John Hsuan, looking for evidence to prove UMC had illegally invested in the Chinese foundry.

The relationship between UMC and Hejian is one of the island's worst kept secrets. Ever since Hejian's founding in 2001, UMC executives have been opaque when asked about their links to the foundry. UMC's chief executive, Jackson Hu, has described the operation as a "friendly" firm that helps out from time to time when UMC has extra orders.

UMC has a lot in common with Hejian: many of Hejian's customers have received investment from UMC; some of Hejian's senior management are former UMC employees; their processes are compatible; and UMC's biggest client, U.S. FPGA company Xilinx Inc., has invested in Hejian. Other key investors include AIG, Softbank, Kawasaki Microelectronics and Daiwa NIF.

While such similarities between foundries sparked a lawsuit alleging IP theft and corporate espionage between Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC) and SMIC, which was recently settled out of court, UMC has remained quiet about any possible technology violations by Hejian.

One of the key aspects of the case for prosecutors is Hejian's alleged use of nearly 200 UMC patents. In a statement to the Taiwan Stock Exchange on Thursday, the foundry said it has not "transferred or sold any of its technology patents to Hejian Technology. Furthermore, UMC will vigorously defend its patent portfolio from any semiconductor company, including Hejian, that threatens the interest of UMC and its shareholders."

However, in his public statement, Tsao acknowledged that Hejian was using UMC patents and said he would not sue Hejian for the infringement because he saw the patents as a negotiating tool in future acquisition talks. The company also denied that UMC transferred equipment to Hejian.

Meanwhile, a Hejian spokesperson said the company only uses patents developed on its own or those that it has bought or licensed from other semiconductor firms. The company also denied "any relationship" with UMC "on any level."

In his statement, Tsao also seemed to indirectly blame TSMC Chairman Morris Chang for the rapid development of SMIC, and the subsequent need for UMC to help create a counterweight to the Shanghai foundry. Tsao said TSMC paid too much for its 2000 acquisition of Worldwide Semiconductor Manufacturing Corp., which enabled Richard Chang, its president at the time, to use some of that money to seed SMIC and threaten Taiwan's dominance of the foundry industry.