Hong Kong's Independent Commission Against Corruption (ICAC) arrested Raymond and Thomas Kwok in the agency's biggest investigation since it was set up in 1974 to root out what was seen as widespread corruption in the government and police.

Rafael Hui, a former No.2 official in the government, was also arrested, according to media reports. Hui resigned as an independent director of insurer AIA Group (1299.HK) (AIG.N) late on Thursday.

The arrests on Thursday come just days after Hong Kong elected Beijing-loyalist Leung Chun-ying as its next leader, pledging land for cheaper public housing, and as soaring property prices, the most expensive in the world, have stirred public discontent. Home prices almost doubled in the five years to end-2011, according to real estate broker Knight Frank.

"This is not good for the image of Hong Kong, which used to have a high reputation for integrity," said Joseph Wong, a former senior government official and colleague of Hui. "The impression is that government policies tend to favor the rich tycoons, particularly rich property developers. These sort of cases will only add to the suspicions."

The two Kwok brothers and Hui were released late on Thursday but were expected to return for more questioning, according to a source familiar with the matter. Local media reporters said the brothers were still inside a Deepwater Bay luxury compound on the south side of Hong Kong on Friday.

The Kwoks are worth $18.3 billion, according to Forbes magazine, the second-biggest family fortune in Hong Kong after Asia's richest man, Li Ka-shing, founder of rival developer Cheung Kong (Holdings) (0001.HK).

Shares in Sun Hung Kai slumped more than 15 percent to 15-week lows when they resumed trading on Friday. The company owns some of the former British colony's largest properties, including its tallest building, the International Commerce Centre that houses Morgan Stanley and the Ritz Carlton.

"This is justice. They're among the biggest, richest men in Hong Kong. The power of the property sector is too strong, but the business-government connection is the same around the world," Terry So, an elderly chauffeur, told Reuters near the Sun Hung Kai Centre.

BUSINESS AS USUAL

Sun Hung Kai said the Kwoks would continue with their duties as chairmen and managing directors, and normal business operations would not be affected.

In the past two weeks, Sun Hung Kai has also disclosed that Thomas Chan Kui-yuen, in charge of project planning and land acquisitions, had been arrested for suspected bribery, and Chan Kai-ming, executive director of architectural and engineering services, had died, peacefully - meaning of the company's seven executive board members, three have been arrested, and one has died.

Hui, who, according to the Hong Kong Jockey Club website, has owned eight racehorses - two co-owned with Henry Tang, a loser in this month's leadership election - has been a long time adviser to Sun Hung Kai and has known the Kwoks since childhood.

Details of what is behind the arrests remain unclear.

The South China Morning Post reported that the ICAC was looking into suspected debts of more than HK$100 million ($12.9 million) linked to Hui, and a related, unsecured loan of HK$50 million.

Hui was Chief Secretary under Hong Kong's leader Donald Tsang in 2005-07, a post that would entitle him to government housing. But he chose to stay in his 4,000 square foot Leighton Hill apartment - a pink and tan marble residential tower that overlooks the Happy Valley racecourse and was developed by Sun Hung Kai.

The unfolding scandal has gripped Hong Kong, the world's most densely populated city which was returned to Chinese rule by the British in 1997.

"It's a sign they're trying to shift the power away from the tycoons," said Alaric Lau, a 45-year-old independent investor in equities and fixed income, who was walking near Hui's residence.

"These are three very prominent people in Hong Kong. The arrests are a sign of how they want to do things going forward ... there's no more favoritism that extends beyond the law ... it's a sign that the Chinese government is changing."

The potential conflict of interest in a senior government official living - rent-free, according to media reports - in an upscale residence owned by an influential property family has not escaped public and media attention.

"We always assumed there was something between property and government. Maybe there'll be more scandals. I think it's a starting point in changing the relationship between government and developers," said Joe Lin, a young marketing professional, during a smoking break near the Sun Hung Kai offices.

Earlier this month, Tsang rejected allegations of ethics violations stemming from a yacht trip with tycoons and the controversial rental of a luxury flat in neighboring Shenzhen.

FAMILY FEUD

The Kwok family had a public feud in 2008 that ended with elder brother Walter being ousted as chairman. Thomas and Raymond, backed by their mother, claimed Walter was mentally unfit to run the business, claims Walter has denied.

That aside, the Kwok brothers - Thomas runs the company's construction and engineering departments, while Raymond looks after legal and financial issues - have a relatively low media profile.

Both are devout Christians, with Thomas the driving force behind a Noah's Ark replica theme park which opened in 2009.

A former company employee who didn't want to be named, said he was "very surprised and very sad" at the arrests. "They are men of integrity. Thomas would always repeat the company's mission - Building Homes with Heart - during meetings and ask staff to treat clients with a true heart," he said.

Others also expressed concern about the impact on Hong Kong's reputation for corporate governance.

"It's demoralizing to see another senior government official has been implicated in questionable behavior," said Jamie Allen, Secretary General of the Asian Corporate Governance Association. "Corporate governance rests on a foundation of clean and strong public government. If people start asking questions about the ethics of senior government officials, then they will start having more doubts about corporate governance."

A loan banker in Hong Kong, who asked not to be named as his bank is a lender to Sun Hung Kai, said there was unlikely to be any significant impact on the company's business.

"No one's going to start cutting their credit lines to the company. Sun Hung Kai isn't going bust because of this. It's not a (mainland Chinese) mid-cap, but a Hong Kong blue-chip with hard assets and very low gearing."

WALTER'S WRIT

In a writ filed in Hong Kong in 2008 as part of his bid to avoid his ouster, Walter Kwok said his brothers repeatedly disagreed with his attempts to improve management at the company. He also said he tried to investigate the sale of a parcel of land in Hong Kong's New Territories at more than the asking price, and look into why construction contracts awarded by Sun Hung Kai went to a select number of contractors.

"There's speculation that ... Walter sort of informed the ICAC that his two younger brothers could be in trouble. Those reports appeared before (last weekend's) Election Day," said Joseph Cheng, a professor in Chinese and Hong Kong politics at the City University of Hong Kong.

"I don't think we should connect this to CY Leung or read too much into the date," he told Reuters by telephone.

Gary Plowman, a former government prosecutor, said he had been to the ICAC and was representing one of the arrested parties, whom he declined to identify. "Nobody has been charged," he said.

"You wouldn't expect the ICAC to go after targets with as high a profile as these three unless they thought they were on fairly firm ground," said barrister Kevin Egan.

The ICAC had an 88 percent conviction rate on the 443 people it prosecuted in 2010.

Over the past four decades, Sun Hung Kai, listed in 1972, has built some of Hong Kong's most expensive property, from luxury hilltop apartment blocks and harbor-front skyscrapers to landmark office buildings.

The company's net profit has soared to HK$48 billion ($6.18 billion) in the year to last June from $10.4 billion two years earlier.

($1 = 7.7643 Hong Kong dollars)

(Additional reporting by Vikram Subhedar, Umesh Desai, Clare Baldwin, Farah Master, Stephen Aldred, Joy Leung, Prakash Chakravarti and Sisi Tang in HONG KONG and Rachel Armstrong in SINGAPORE; Writing by Michael Flaherty; Editing by Nick Macfie and Ian Geoghegan)

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