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INTRODUCTION:
Various scams, scandals and stigmas have surfaced in the recent years. These may not all be
attributable to the antics and bungling of politicians, but they have been facilitated largely
because of the vitiated atmosphere that the politicians and the political system have created in the
country.
The Securities Scam refers to a diversion of funds to the tune of Rs. 5,000 crores from the
banking system to various stockbrokers in a series of transactions (primarily in Government
securities) during the period April 1991 to May 1992.
"There's this theory about the next fool around the corner," says G.V. Ramakrishna. "But we may
not have an inexhaustible supply of fools, the men who are left holding the can when there's
nobody at all to pay a higher price."
As the rapidly breaking scandal in the finance markets and the share bazaar spreads, the
Securities and Exchange Board of India chairman's comment appears to be right on target.
With one modification: people like stockbroker Harshad Mehta don't need an inexhaustible
supply of fools. Just adequate will do. This, and the added advantage of being at the right place at
the right time with the right game plan, could only be a winning combination.
It was. For him, and anybody associated with him. But now that the game has come unstuck, it is
becoming clear that the flamboyant 37-year-old Mehta, a fast-talking, fast-dealing high-roller is
at the centre of the biggest financial and insider trading scam ever in the country's history.
The money involved in the past one year alone could be as much as Rs 6,000 crore or more,
taken from banks in various ways to play the booming stock-markets.1
CHAPTER II
HARSHAD MEHTA SCAM
He was later charged with 72 criminal offenses and more than 600 civil action suits were filed
against him
He died in 2002 of a massive heart attack in a jail in Thane, with many litigations still pending
against him.
Diversion of Funds
Intra-day Trading
Diversion of Funds Diversion of funds from the banking system to brokers for financing their
operations in the stock market.
Intra-day trading The modus operandi mainly included investing heavily in certain shares at
the start of the day which led to sharp increase in the price of the stock and then cashing in at the
end of the day to reap huge benefits.
Taking advantages of the loopholes in the banking system, Harshad and his associates triggered a
securities scam diverting funds to the tune of Rs 4000 Cr. from the banks to stockbrokers from
April 1991 to May 1992. He caused the steep rise in the Stock market index in the year 1992 by
bidding at a premium for many shares.
Some of the stocks which were highly invested in by Harshad Mehta were:
ACC
Apollo Tyres
Reliance
Tata Iron and Steel Co. (TISCO)
BPL
Sterlite
Videocon
In early 1990s, Banks in India had to maintain a fixed ratio of their deposits in the form of
Government securities/bonds which was governed by the statutory liquidity ratio (SLR). This
obligation on the part of the banks required them to show a detailed sheet of its stock of
Government bonds at the end of every day. Soon after the rule changed and the banks were not
required to show these details at end of everyday rather they were allowed to show in once in a
week i.e. Friday.
This allowed the banks to sell their bonds in the earlier part of their week and then buy it back in
the later part. This helped them make some profits as they could invest the money that they got
by selling the bonds. The whole process of byying and selling the bonds was taken care of by
brokers and only they knew the two parties which were involved. Individual banks did not have
any idea as to who the other party in the whole transaction was.
In this settlement process, deliveries of securities and payments are made through the broker.
That is, the seller hands over the securities to the broker who passes them on to the buyer, while
the buyer gives the cheque to the broker who then makes the payment to the seller.
In this settlement process, the buyer and the seller may not even know whom they have traded
with, both being known only to the broker.
There were two important reasons why the broker intermediated settlement began to be used in
the government securities markets:
The brokers instead of merely bringing buyers and sellers together started taking positions in the
market. In other words, they started trading on their own account, and in a sense became market
makers in some securities thereby imparting greater liquidity to the markets.
When a bank wanted to conceal the fact that it was doing an RF deal, the broker came in handy.
The broker provided contract notes for this purpose with fictitious counter parties, but arranged
for the actual settlement to take place with the correct counter party.
Privileged (corporate) customers were routinely allowed to credit account payee cheques in
favour of a bank into their own accounts to avoid clearing delays, thereby reducing the interest
lost on the amount.Normally, if a customer obtains a cheque in his own favour and deposits it
into his own account, it may take a day or two for the cheque to be cleared and for the funds to
become available to the customer. At 15% interest, the interest loss on a clearing delay of two
days for a Rs. 100 crores cheque is about Rs. 8 lakhs.
On the other hand, when banks make payments to each other by writing cheques on their account
with the RBI, these cheques are cleared on the same day.
The practice which thus emerged was that a customer would obtain a cheque drawn on the RBI
favoring not himself but his bank. The bank would get the money and credit his account the same
day.
The brokers asked the banks to give the cheques in their own name claiming that they will pay to
the other party on their own. The practice thus emerged was that the broker would obtain a
cheque drawn on the RBI favouring not himself but his bank and the bank would get the money
and transfer it to the broker account on the same day. This helped the brokers to get the money as
soon as the transaction is made which could further be used to be channelled into the stock
market.
In practice, borrowing bank gives a Bank Receipt (BR) instead of delivering the actual securities
to the lender. Bank receipts serve three functions
It confirms the sale of securities
Promises to deliver the securities to the buyer. It states that the securities are held by the seller in
trust for the buyer.
Acts as a receipt for the received money by the selling bank
A BR means that the issuer holds the securities in trust for the buyer, but there is a possibility
that the issuer may not have the securities at all. Following are the reasons for a bank to issue a
BR which is not backed by actual securities
A bank may also short sell securities, i.e. bank will sell securities it doesnt have.
This will be done if the bank anticipates fall in prices. Bank buys securities at lower prices when
they fall in value and discharges the BR.
Bank may do an RF deal and issue a fake BR (not backed by securities) if banks simply want an
unsecured loan , where a lending bank would be under the impression that its dealing with a
secured loan but in reality its advancing an unsecured loan. Though, lenders should have taken
measures to protect themselves .
During the scam, brokers were so perfect in the art of using fake BRs and obtained unsecured
loans from various banks. They managed to persuade little known bank s like the Bank of Karad
(BOK) and the metropolitan Cooperative Bank (MCB) to issue BRs and then these BRs were
used to do RF deals with other banks. This way several large banks made huge unsecured loans
to these banks and thus it created money for the brokers.
Whenever an RF deal is done by using BRs rather than actual securities, the lending bank has to
contend with the possibility that it may be making an unsecured loan. This requires assigning
credit limit to the borrower by assessing the creditworthiness of the borrower.
The different aspects of securities transactions of a bank are carried out by different persons
CHAPTER III
IMPACT OF THE SCAM
There was a lot of media coverage on the scam and the political parties left no opportunity in
criticizing the government for it. The government was under immense pressure and its
liberalization policies were severely criticized. It was also believed that Harshad Mehta and his
accomplices were behind framing of these policies. In the end the government had to put the
liberalization plans on hold. SEBI had to postpone the sanctioning of private sector mutual funds.
Implementation of some aspects of the Narasimham Committee recommendations on the
banking system had to be delayed. The much talked about entry of foreign pension funds and
mutual funds became more remote than ever. The Euro-issues planned by several Indian
companies were delayed since the ability of Indian companies to raise equity capital in world
markets was severely compromised.
3.3 IMPACT ON THE BANKS
Fake bank receipts (BR) which were an integral part of the execution of the whole scam landed
the banks involved in a tight spot. These BR were declared void and public money was at stake.
At least ten prominent banks were involved in this; some of them being SBI, Standard Chartered
and a subsidiary of RBI. The scam could have been checked in time with proper policies and
verifications. The government, the RBI and the commercial banks are as much accountable as
the brokers for the scam. The brokers were encouraged by the banks to divert funds from the
banking system to the stock market. The RBI too stood indicted because despite knowledge
about banks over-stepping the boundaries demarcating their arena of operations, it failed to
check them. Some of the prominent individuals who were penalized were K. M. Margabandhu,
CMD of the UCO Bank (Arrested and sacked) and V. Mahadevan, one of the MD the State Bank
of India (Suspended)
The government, the RBI and the commercial banks were as much accountable as the brokers for
this scam. The brokers were encouraged by the banks to invest their funds in the stock market in
place of investing in the banking system. The RBI was also responsible for this scam because
despite knowledge about banks over-stepping the boundaries demarcating their arena of
operations, it failed to reign them in. RBI didnt take any action against the commercial banks.
The looting was done with full knowledge of the very individuals appointed by the government
who were responsible to guard against such a possibility. So the Harshad Mehtas scam could
have been detected earlier if either of the above (commercial banks, RBI or government) parties
not encourage the brokers to invest in the stock market.
also the not so obviously guilty (the bank executives, the bureaucrats and perhaps the politicians)
are identified and brought to book. These types of investigations are not only very time
consuming but also very expensive.
3.8 JUDGEMENT
He was later charged with 72 criminal offenses and more than 600 civil action suits were filed
against him. By the time he died , Mehta had been convicted in only one of the many cases filed
against him. He died in 2002 of a massive heart attack in a jail in Thane, with many litigations
still pending against him.
CHAPTER IV
CONCLUSION
Corporate Governance is the value framework, ethical framework and moral framework within
which businesses make decisions .When large sums of money are involved, greed causes people
to become unethical. There was a total lack of transparency in the money market. Irregularities of
all kind were so common that no suspicion aroused even by highly irregular transactions. This is
the ideal environment for a scam to germinate and grow to alarming proportions. The most
constructive response to the scam would be in the arena of reforms of the financial system. In our
view, the origins of the scam lie in over-regulation of our markets. The regulations in the money
markets were such that thoroughly legitimate and essential transactions could not be put through
openly, but had to be disguised and camouflaged. The role of the brokers and of some of the
banks as market makers was not recognized and they could perform these important and useful
functions only by subterfuge. The payment and clearance system was so antiquated and
cumbersome that totally indefensible methods had to be adopted to achieve speedy funds
transfers. The net result of all these was a total lack of transparency in the operations in the
money market. Irregularities of all kinds were so common that no suspicions were aroused even
by highly irregular transactions. The situation was an ideal environment for a scam to germinate
and grow to alarming proportions. We would even argue that some of the control systems in the
banks broke down because they had been deliberately allowed to weaken by both the commercial
banks as well as the RBI in order to facilitate normal transactions in violation of the RBI
guidelines.
BIBLIOGRAPHY
REFERENCES
http://en.wikipedia.org/wiki/Harshad_Mehta
http://www.bullrider.in/harshad-mehta-stock-scam/
http://investmentpark.blogspot.com/2007/02/harshad-mehta-scam-1992.html
http://www.scribd.com/doc/17227215/Harshad-Mehta-Scam
http://wiki.answers.com/Q/Can_you_give_the_details_about_the_Harshad_Mehta_sca m
http://www.authorstream.com/Presentation/pratm_18-486267-harshad-mehta-and-ketanparekh-scam/
http://www.slideserve.com/PPTFiles/insights_investing_jul08_29542_32424.ppt