Harshad Mehta Scam

This article is aimed towards discussing the ‘Harshad Mehta Scam.’ The article talks about the kind of a scam which was primarily based on the loopholes of the Indian banking system. The article majorly covers the stages of the scam, the type of instruments used in this scam, the working of those instruments, the various offence committed, the amendments which took place in the legislation, and the current legal position of India.
Estimated Reading Time: 10 minutes

Introduction

A wise man famously quoted, “there is no substitution to hard work.” If a person sees an opportunity to achieve something in ease by a ‘scheme,’ which otherwise had required the right amount of money, time, or energy, he should know that it is nothing but a scam as in the case of Harshad Mehta.

This article is aimed towards discussing the most famous Stock Market Scam of India in 1992, also known as the ‘Harshad Mehta Scam.’ The article majorly covers the stages of the scam, the type of instruments used in this scam, the working of those instruments, the various offenses committed, the amendments which took place in the legislation, and the current legal position of India.

Background

Harshad Shantilal Mehta was born in Paneli Moti, Gujarat, on 29th July 1954 to Shantilal Mehta, who was a small businessman, and Rasilaben Mehta. He completed his graduation in 1976 with a B.com degree from Lala Lajpatrai College, Mumbai. Initially, he began working at various places like New India Assurance Company as a salesperson. After having an experience of about eight years, he entered into the broking houses of Mumbai, such as P. Ambala, P.D. Shukla, J.L. Shah, Nandalal Sheth, etc.[1]

In 1984, he, along with his brothers named Ashwin Mehta and Sudhir Mehta, formed his own company called ‘Grow More Research and Asset Management Company,’ which gave investment services to its clients. He further enhanced his business by becoming a broker of the Bombay Stock Exchange (BSE) Company. He was later known as ‘Amitabh Bachchan of Stock Market’[2] and ‘The Big Bull.’

Initial stages of the scam

In 1990, he began entering into the market for purchasing stocks in colossal amounts and rapidly increasing its prices. Some of the significant stocks which he dealt with were: Apollo Tyres, Reliance, Tata Iron and Steel Company, VIDEOCON and Associated Cement Company (ACC).[3] This process of purchasing the stocks and selling it at higher rates was still a decent method of doing business.

However, his business was not simple. He used the method of lobbying to increase stock rates. Lobbying, in this context, means to manipulate the stock market.[4] To do that, a group of persons enter together into a share, pump in much money and hence, increase its demand. Stock tip, which means a piece of inside information or confidential notice about a particular stock, plays a crucial role in this process. 

For instance, to sell a share of Apollo Tyres of worth Rs. 100, he produced news of the share as a tip stating, “the target rate is of Rs. 180 but purchase it at Rs. 110”. Initially, nobody pays attention to the tip as there are already thousands of tips floating in the market. Due to lobbying, the demand gets increased by the share, which increased the selling price to Rs. 120. The general public now realizes that the initial price was Rs. 110, has been crossed, and to not let it cross further, a massive number of people arise to buy that share, which again leads to the increase in its demand. So, this increase in demand again increases the price of the share, and now the price rose to Rs. 140. The general public, who is manipulated by the artificial demand, starts believing in the tip, which was initially launched, and they start investing their money in the share. At this point, the lobbying people exit from the market as the general public themselves are increasing its demand.

As thousands of people started investing in the share, the lobbying persons put all the shares for selling, and due to the selling pressure, the market price crashes. This disturbs the fundamentals of the market as the market should work purely on demand and supply basis. This is called an artificial creation of a demand which is illegal.

The repercussion of Artificial Demand in the Market

Harshad Mehta extensively targeted one company, Associated Cement Company (ACC). Initially, ACC used to be traded at Rs. 200 per share. However, by the creation of artificial demand, through lobbying and tips, the rate of the share increased to Rs. 9000 per share in a short period. People were astonished by such an increase in the price of the share that they even started investing their borrowed funds into it. The percentage return on investment of the share became of about 4500%.[5] It was termed as a ‘bull phase,’ i.e., the rising phase.[6] This matter became the talk of the town.

Instruments used in the scam

1. Ready Forward Deal

When the government is short of funds for its functioning, it compels the banks to buy government securities. In return, the bank pays money to the government. Most of the time, the banks suffer from blockage of liquidity. The only possible option which the banks have in this situation is that they, for a short period, give the government securities to another bank on loan. This was termed as the ‘ready forward deal.’ To make this deal with another bank, a broker is being appointed. The broker act as a bridge between the two banks, which are unknown to each other, and against this job, he gets his commission. Suppose Bank A wants to sell government securities. It will give the securities to the broker so that he will find buying bank, Bank B, and the broker will sell the securities to it. Bank A would directly take the money from the broker without even knowing about the identity of Bank B. The whole settlement process of securities and payment was done through the broker as a mediator. Both the buying and selling banks never interrogated the broker to the identity of the other bank.

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Harshad Mehta took benefit of these loopholes in the banking system and the ‘time gap’ given to a broker. When he used to get the securities, for instance, from the selling bank for few days until he finds a deal, in the meanwhile, he used to approach buying bank and makes a deal with it that they can give him the money and in return, he will find the seller of securities in few days. Another loophole in this process was that the buying bank used to draw the cheque in his name.[7] Therefore, at one point in time, Harshad Mehta had the possession of both securities and money, while both the banks stay in the illusion that the broker is finding them a good deal.

The money which he had in possession, was being used in the investment of stocks and hence, he managed his lobbying business. On the other hand, if the selling bank, who was initially suffering from liquidity blockage, pressurized him for the money, in that case, he used to give selling bank the money from his bull phase profit. However, in case if there was no bull phase situation, he used to approach a third buying bank, take money from it, and transferred the money to the selling bank. This way, Harshad Mehta made a series of a chain of the ready forward deal, and gradually, he became more prosperous. Soon, he even became Mumbai’s highest taxpayer during that time.

2. Bank Receipts

The banks, after selling the securities and receiving money, used to produce a Bank Receipt, which acted as an acknowledgment for the buying banks. Harshad Mehta’s scam was so widely spread that he even started making fake Bank Receipts. In this manner, he got the banks into an illusion that their money is being safely transferred to the selling bank.

For the making of fake Bank Receipts, he required the help of the employees of such a bank, which was not backed by any government securities. Accordingly, he tied up with two banks, namely, The Bank of Karad (BOK) and The Mumbai Mercantile Cooperative Bank (MCB).[8]

However, the work of fake receipts remained very confidential, which is why, for several months, he was successful in using this illegal method. His work involved no error. The only loophole remained was upon the lender bank, who never realized that they always made the cheques in the name of Harshad Mehta, who was merely a broker. The banks were unaware of the RBI norms, which states that the lender bank must give cheque in the name of the borrower bank.[9] Nevertheless, since he was engaged in a massive number of deals at a time, the banks trusted him for his work.

Exposure of securities scam

It is righty said, “Pen is mightier than swords.” On 23rd April 1992, a journalist named, Sucheta Dalal, published an article about the Harshad Mehta’s scam in the Times of India.[10] She was the first person who studied the work of this scam and exposed it in public. After that, the matter was looked into by the authorities who declared the scam to be true.

Impact of the scam

The total loss suffered by banks was approximately Rs. 3,000 to 4,000 crores. This resulted in a deadly crash in the stock market.[11] Moreover, the Sensex, which had drastically risen to 4,500 during the phase of scam, fell again to 2,500, which means that there was a loss of Rs. 1,00,000 crores in market capitalization.[12]

During that time, the ruling party was Indian National Congress (INC) with P.V. Narasimha Rao as the then Prime Minister of India. To contain the consequences of the scam, the government took the following steps;

  1. In 1991, the government of India brought a policy called LPG, i.e., Liberalization, Privatisation, and Globalisation. However, the government put the liberalization policy on hold due to the scam. There were restrictions imposed on the freedom of private businesses to ensure safety.
  2. The government placed restrictions on the foreign capital inflow for one year.
  3. Since the making of fake Bank Receipts played a crucial role in the scam, Reserve Bank of India (RBI) completely removed the concept of Bank Receipts in India.
  4. The approval of private sector mutual funds, given by the Securities and Exchange Board of India (SEBI), was also postponed.
  5. Harshad Mehta was banned for life by SEBI to invest in the stock market.
  6. In 2001, ‘naked short sales,’ which means the process of selling and buying of government securities amongst the banks without knowing each other’s identity, was prohibited in India.
  7. The Law Commission of India introduced the Securities and Exchange Board of India (SEBI) Act, 1992, which was initially a non-statutory body formed in 1988 for regulating the securities market in India. Hence, a statutory power was conferred to it.
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Legal actions

After the exposure of the scam, there was a raid conducted by the tax department at the house of Harshad Mehta and several documents and certificates were seized. There were more than 600 civil suits along with 72 criminal offenses against him. He was completely prohibited from the stock market by the court.[13] His two brothers and all the other related persons were also not allowed in the stock market for a lifetime.

Majorly, there were four groups of brokers involved in the scam. They are as follows;[14]

  1. Harshad Shantilal Mehta Group
  2. Bhupen Dalal Group
  3. Hiten Dalal Group
  4. Ajay Kayan Group

One of the most critical cases in this regard was the defrauding of the State Bank of India (SBI) with the amount Rs. 600 crores. Also, the other banks were shocked to find that they have been storing fake Bank Receipts having no value.

On 9th November 1992, Harshad Mehta and his brothers were arrested by the Criminal Bureau of Investigation (CBI). He was convicted by the Bombay High Court and the Supreme Court of India for the financial scandal of Rs. 4,999 crores. Out of 27 criminal charges against him, he was only convicted of 4 upon his death.

The unfortunate death

When Harshad Mehta was in the judicial custody in Thane prison, he informed the authorities that he has a slight pain in his chest. He was then taken to the hospital and later on 31st December 2001, at the age of 47, he passed away. However, his death remained a mystery. Some believed that he was murdered by an underworld nexus, but no such investigation happened.

The aftermath

Even after the death of Harshad Mehta, his family had to visit the court because of the pending cases frequently. In one of the cases, his wife, Jyoti Mehta, claimed Rs. 6 crores from the Federal Bank and a stockbroker, Kishore Janani, owed by her husband. This judgment was held in her favour. The court also ordered the broker to pay the principal with an 18% interested until the whole amount is cleared. This was calculated to be approximately Rs—524 crores, which were used to pay the debtors of Harshad Mehta.

Conclusion

Keeping in mind the purchasing power of India during that time, it can be rightly said that the Harshad Mehta Scam was the most prominent and deadliest scandal ever happened in India. A majority of people lost their life savings in this scam, and many even tried to commit suicide. From top industrialists to roadside vendors, whenever the term stock market scandal was used, the name of Harshad Mehta always came into their minds. He became the king of scams. The scam not only shook everyone with its consequences but also helped in highlighting the loopholes in the banking systems and stock markets.

Also read https://thecompany.ninja/2g-spectrum-scam/


[1]Aishwarya P.T., A Case Study on Harshad Mehta, L.S., January 2017, 12.

[2]Pallavi Prasad, Harshad Mehta: The Baap of Bank Frauds Before Nirav Modi, T.Q., April 24, 2018, 2.

[3]Edward A. Gargan, Huge Financial Scandal Shakes Indian Politics, N.Y.T., June 1992, Section D, 15.

[4]Lobbying, Black’s Law Dictionary, (10th ed. 2014).

[5]M. Mumbaikar, The big bull – Harshad Mehta, T.Q., 15 Aug 2010, 13.

[6]Bull market, Cambridge Advanced Learner’s Dictionary, (3rd ed. 2008).

[7]Harshad Mehta Scam, I.M., Dec 1999, https://www.indianmirror.com/indian-industries/indian-scams/harshadmehta.html.

[8]Tania Gupta, The 1992 Securities Scam, P. Blog & Tech., February 26, 2017, https://medium.com/pragyan-blog/the-1992-securities-scam-6a2642888e31.

[9]Vishwa, Indian Scandals, O.S. Blogs, October 2, 2016, http://ourindianscandals.blogspot.com/2016/10/harshad-mehta-securities-scam-5000.html.

[10]Samir K. Barua, How Harshad Mehta Got Caught!, H.N. Service, January 12, 2008, https://thehimalayantimes.com/business/how-harshad-mehta-got-caught/.

[11]Sucheta Dalal. (1999). Harshad Mehta’s Conviction: How Not to Handle Financial Crimes. Economic and Political Weekly, 34(40), 2833-2834

[12]Pravin Palande, Economic Milestone: Stock Market Scam (1992), India Forbes, August 20, 2014, https://www.forbesindia.com/article/independence-day-special/economic-milestone-stock-market-scam-(1992)/38457.

[13]Onkar Singh, CBI arrests Harshad Mehta, brothers, November 9, 2001,https://www.rediff.com/money/2001/nov/09mehta.html.

[14]Sumit Moitra, Harshad Mehta scam: When a financial scandal triggered reforms in India, July 23, 2016, https://www.dnaindia.com/business/report-harshad-mehta-scam-when-a-financial-scandal-triggered-reforms-in-india-2237149.

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