Lee, who posted a 3-under 69 in the second round, and Pepper are tied at 6-under-par 138 at Mission Hills Country Club.
Former champion Karrie Webb (71), overnight leader Aree Song (73) and Wendy Doolan (69) share third place. The trio is knotted at 5-under-par 139, one shot behind the co-leaders.
Friday's rounds lasted over six hours and Lee's playing partners, Nanci Bowen and Heather Daly-Donofrio, who were the last group, elected to mark their putts on 18 instead of finishing. Those two will return to the course at 9:45 AM (ET) Saturday, then the 36-hole cut and the third round.
Annika Sorenstam stated at the beginning of this 2004 campaign that one of her goals was to win the single-season Grand Slam. That is in serious jeopardy as she struggled to a 4-over 76 and is tied for 37th place at 3 over par for the championship.
'There's two days and I've come back from further behind in one day,' said Sorenstam, who won this title in 2001-02.
Michelle Wie, who played in the last group on Sunday in last year's event, managed an even-par 72 on Friday and is part of a group in seventh place at 3-under-par 141.
'I'm happy I shot even-par because it could have been worse,' acknowledged Wie, who played in the Sony Open in Hawaii on the PGA Tour earlier this season.
It was a difficult day for most as cooler temperatures and higher winds made the round different from Thursday, when it was warm and relatively calm.
Wie tallied three bogeys and three birdies in her round on Friday, but her putting was suspect. At the first, she missed the green, then two-putted from nine feet. She also two-putted for bogeys from eight feet and 15 feet at the eighth and 17th holes, respectively.
Wie, 14, collected a pair of birdies in a three-hole span starting at the fourth, then reached the green in two and two-putted for birdie from 30 feet at the 11th.
Wie is now five strokes ahead of her pace from last year, when she tied for ninth.
'I'm happy with that,' said Wie. 'This year's conditions feel a lot harder than last year, where it was perfect conditions. This year it's a little windy and I'm very proud of myself.'
While Wie is one of the big stories this week, she still has ground to make up on the leaders.
Pepper, who won this event in 1992 and 1999, began the round two shots behind Song and wasted little time in cutting into the deficit. Pepper reached the green in two at the par-5 second and two-putted from 45 feet for birdie.
Pepper tallied her second birdie of the round at the fourth hole when she knocked a 4-iron to 25 feet and canned the putt. She parred her next five holes before a 25-foot birdie putt at the 10th took her to 7 under par for the championship.
Her first miscue of the round came at the par-4 12th. Pepper missed the green with a 5-iron at the 385-yard hole and hit a poor chip that stopped 12 feet from the hole. She missed the par-saving putt, but was still atop the leaderboard.
Pepper hit a spectacular shot at the par-3 17th that finished four feet past the hole. The putt had a lot of break and with the wind howling, Pepper missed the short putt.
Pepper was not able to birdie the par-5 closing hole, but this is still a huge step. She missed basically all of the 2002 season after shoulder surgery and last year battled a painful sinus condition that kept her out of action for most of the year.
'More than anything, I'm happy to be healthy,' said Pepper, who still owns the tournament scoring record at 19-under-par 269 when she won in '99. 'I needed to keep playing and then you come to a tournament like this, where it's not a birdie fest and where the conditions are tough and it played right into what my preparation had been.'
Lee, a 25-year-old Korean, birdied her first three holes and added a fourth birdie on her front side at the seventh. Things came apart a bit for Lee on the back nine as she missed a five-footer for par at the 14th and drove into the rough en route to another bogey at 16.
Lee hit a 5-iron to seven feet which set up birdie at No. 17. Now tied with Pepper, Lee was the only member of her playing trio to finish up the 18th.
'I don't want to wait until tomorrow morning so I just kept playing,' said Lee. 'Everything is fine. I'm chipping well, my putting was very good and my driver was pretty far and straight.'
Rosie Jones is alone in sixth place at minus-4, followed by Wie, Grace Park (69) and Mi-Hyun Kim (70), who are tied at 3-under-par 141.