Harshad Mehta Case

8/16/2019 Harshad Mehta Case

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CHAPTER I

Introduction and Research Methodology

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

baning system to various stocbroers in a series of transactions !primarily in "overnmentsecurities# during the period $pril %&&% to 'ay %&&(.

)There*s this theory about the ne+t fool around the corner,) says G.V. Ramakrishna. )ut -e may

not have an ine+haustible supply of fools, the men -ho are left holding the can -hen there*s

nobody at all to pay a higher price.)

$s the rapidly breaing scandal in the finance marets and the share baaar spreads, the

Securities and /+change oard of ndia chairman*s comment appears to be right on target.

1ith one modification2 people lie stocbroer 3arshad 'ehta don*t need an ine+haustible

supply of fools. 4ust adeuate -ill do. This, and the added advantage of being at the right place atthe right time -ith the right game plan, could only be a -inning combination.

t -as. 6or him, and anybody associated -ith him. ut no- that the game has come unstuc, it is

becoming clear that the flamboyant 789year9old 'ehta, a fast9taling, fast9dealing high9roller 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 :,000 crore or more,

taen from bans in various -ays to play the booming stoc9marets.%

1 http://indiatoday.intoday.in/story/securities-scam-harshad-mehta-throws-banking-

system-stock-markets-into-turmoil/1/306969.html visited on 3 pril !" #016 at #.1$

pm

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1! O"#ECTI$E O% THE &TUD'

The research pro;ect has been carried out -ith the follo-ing ob;ectives2

The basic ob;ective behind carrying out this research pro;ect is to study about securities

scam -ith reference to 3arshad 'ehta scam To no- about causes of the scam and its impact on ndian economy.

1( RE&EARCH METHOD)O*'

The uality and value of research depends upon the proper and particular methodology adopted

for the completion of research -or.


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CHAPTER II

HAR&HAD MEHTA &CAM

!1 "RIE% A"OUT HAR&HAD MEHTA

3arshad Shantilal 'ehta -as born on (& 4uly in a "u;arati 4ain family of modest means.

6ather 2 'r Shantilal 'ehta, a small businessman

'oved from small to-n Raipur to find his future in 'umbai

6irst ;ob as dispatch cler in the >e- ndia $ssurance

1ored -ith stoc broers and soon managed to get a broers? card

Soon started his o-n venture2 "ro- 'ore Research and $sset 'anagement @ompany


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3e -as later charged -ith 8( criminal offenses and more than :00 civil action suits -ere filed

against him

3e died in (00( of a massive heart attac in a ;ail in Thane, -ith many litigations still pending

against him.

!! O$ER$IE+ O% THE &CAM

This scam can be categoried as a @apital 'aret scam in -hich it is done by manipulating the

facts in order to attain enormous profits. There -ere D different aspects of this scam2

Civersion of 6unds

ntra9day Trading

Ese of Ready 6or-ard!R6# to maintain S


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Taing advantages of the loopholes in the baning system, 3arshad and his associates triggered a

securities scam diverting funds to the tune of Rs D000 @r. from the bans to stocbroers from

$pril %&&% to 'ay %&&(. 3e caused the steep rise in the Stoc maret inde+ in the year %&&( by

bidding at a premium for many shares.

Some of the stocs -hich -ere highly invested in by 3arshad 'ehta -ere2

$@@

$pollo Tyres

Reliance

Tata ron and Steel @o. !TS@B#

A<

Sterlite

Videocon

!( READ' %OR+ARD ,R%- . MODU& OPERANDI

Ready for-ard is actually a sort of a short term loan !typically %5 days or less# usually from one ban to another. Enlie other loans, it is actually a secured loan -ith "overnment securities

bacing it up. n essence, it?s lie one ban selling its securities to another -ith a promise of

buying it bac at a pre9determined price.

n early %&&0s, ans in ndia had to maintain a fi+ed ratio of their deposits in the form of

"overnment securitiesFbonds -hich -as governed by the statutory liuidity ratio !S


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by selling the bonds. The -hole process of byying and selling the bonds -as taen care of by

broers and only they ne- the t-o parties -hich -ere involved. ndividual bans did not have

any idea as to -ho the other party in the -hole transaction -as.

The -hole process can be described in 7 phases2

Settlement Arocess

Aayment cheues

Cispensing of securities

!/ &ETT)EMENT PROCE&&

The normal settlement process in government securities is that the transacting bans mae

payments and deliver the securities directly to each other. Curing the scam, ho-ever, the bans

or at least some bans adopted an alternative settlement process -hich -as similar to the process

used for settling transactions in the stoc maret.

n this settlement process, deliveries of securities and payments are made through the broer.

That is, the seller hands over the securities to the broer -ho passes them on to the buyer, -hile

the buyer gives the cheue to the broer -ho then maes the payment to the seller.

n this settlement process, the buyer and the seller may not even no- -hom they have traded

-ith, both being no-n only to the broer.

There -ere t-o important reasons -hy the broer intermediated settlement began to be used in

the government securities marets2


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The broers instead of merely bringing buyers and sellers together started taing positions in the

maret. n other -ords, they started trading on their o-n account, and in a sense became maret

maers in some securities thereby imparting greater liuidity to the marets.

1hen a ban -anted to conceal the fact that it -as doing an R6 deal, the broer came in handy.

The broer provided contract notes for this purpose -ith fictitious counter parties, but arrangedfor the actual settlement to tae place -ith the correct counter party.

!0 PA'MENT CHEUE&

$ broer intermediated settlement allo-ed the broer to lay his hands on the cheue as it -ent

from one ban to another through him. The hurdle no- -as to find a -ay of crediting the cheue

to his account though it -as dra-n in favor of a ban and -as crossed account payee. $s it

happens, it is purely a matter of baning custom that an account payee cheue is paid only to the

payee mentioned on the cheue. n fact, e+ceptions -ere being made to this norm, -ell before

the scam came to light.

Arivileged !corporate# customers -ere routinely allo-ed to credit account payee cheues in

favour of a ban into their o-n accounts to avoid clearing delays, thereby reducing the interest

lost on the amount.>ormally, if a customer obtains a cheue in his o-n favour and deposits it

into his o-n account, it may tae a day or t-o for the cheue to be cleared and for the funds to

become available to the customer. $t %5G interest, the interest loss on a clearing delay of t-o

days for a Rs. %00 crores cheue is about Rs. H lahs.

Bn the other hand, -hen bans mae payments to each other by -riting cheues on their account

-ith the R, these cheues are cleared on the same day.

The practice -hich thus emerged -as that a customer -ould obtain a cheue dra-n on the R

favoring not himself but his ban. The ban -ould get the money and credit his account the same

day.

The broers ased the bans to give the cheues in their o-n name claiming that they -ill pay to

the other party on their o-n. The practice thus emerged -as that the broer -ould obtain a

cheue dra-n on the R favouring not himself but his ban and the ban -ould get the money

and transfer it to the broer account on the same day. This helped the broers to get the money as


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soon as the transaction is made -hich could further be used to be channelled into the stoc

maret.

!2 DI&PEN&IN* O% &ECURITIE&

3ere the broers used their credibility to persuade the bans to part -ith the cheues -ithout

actually receiving the securities -ith the promise that they -ill get the securities the ne+t day

-ith a %5G interest for one day. an officials -ere bribed to accomplish this tas as this -as

illegal on the part of the bans to let go of their money -ithout any assurance. This -as 3arshad

'ehta and his associates -ere able to use the money of the bans -hich -as eventually used for

speculating in the stoc maret.

!3 "AN4 RECEIPT&

$nother instrument used in this scam -as the ban receipt !R#. n an R6 deal, securities -ere

not moved bac and forth in actuality. nstead, the borro-er, -ho is the seller of securities, gave

the buyer of the securities a R.

n practice, borro-ing ban gives a an Receipt !R# instead of delivering the actual securities

to the lender. an receipts serve three functions =

t confirms the sale of securities

Aromises to deliver the securities to the buyer. t states that the securities are held by the seller in

trust for the buyer.

$cts as a receipt for the received money by the selling ban

$ R 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. 6ollo-ing are the reasons for a ban to issue aR -hich is not baced by actual securities =

$ ban may also short sell securities, i.e. ban -ill sell securities it doesn?t have.


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This -ill be done if the ban anticipates fall in prices. an buys securities at lo-er prices -hen

they fall in value and discharges the R.

an may do an R6 deal and issue a fae R !not baced by securities# if bans simply -ant an

unsecured loan , -here a lending ban -ould be under the impression that it?s dealing -ith a

secured loan but in reality it?s advancing an unsecured loan. Though, lenders should have taen

measures to protect themselves .

Curing the scam, broers -ere so perfect in the art of using fae Rs and obtained unsecured

loans from various bans. They managed to persuade little no-n ban s lie the an of Iarad

!BI# and the metropolitan @ooperative an !'@# to issue Rs and then these Rs -ereused to do R6 deals -ith other bans. This -ay several large bans made huge unsecured loans

to these bans and thus it created money for the broers.

!5 CONTRO) &'&TEM&

There -as a complete breado-n of the control system -ithin the commercial bans and that of

R. 6ollo-ing features are involved in the internal control system2

1henever an R6 deal is done by using Rs rather than actual securities, the lending ban has to

contend -ith the possibility that it may be maing an unsecured loan. This reuires assigning

credit limit to the borro-er by assessing the credit-orthiness of the borro-er.

The different aspects of securities transactions of a ban are carried out by different persons

!6 DI&APPEARANCE O% MONE'

t is becoming increasingly clear that despite the intensive efforts by several investigating

agencies, it -ould be impossible to trace all the money s-indled from the bans. $t this stage -e

can only con;ecture about -here the money has gone and -hat part of the misappropriated

amount -ould be recovered.


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!17 UNETHICA) I&&UE& IN MEHTA &CAM

maginary companies created.

ought the shares of o-n company by himself causing Sense+ up.

Aurchased 3uge amount of shares of a targeted company lie $@@ .

@aused false bull run.

@reated fae Rs, or Rs not baced by any government securities.

llegally issue of R by small ban.

1ithout verification, bans lie “Vi;aya an” issued the cheue.

Recommendation to purchase particular shares on his o-n -ebsite.

CHAPTER III

IMPACT O% THE &CAM

(1 IMMEDIATE IMPACT A%TER &CANDE)

$fter the 3arshad 'ehta scandal -as e+posed, $pril, %&&(, the situation in share maret -as that

of utter chaos. The first impact of the scam -as a steep fall in the share prices. The inde+ fell

from D500 to (500 representing a loss of Rs. %00,000 crores in maret capitaliation. 3o-ever,

the ma;or damage to the stoc maret did not stop here. Since the accused -ere active broers in

the stoc marets, they had traded a large number of shares during the previous year. $ll theseshares became tainted and -orthless and could not be used in the maret. This -as a great loss to

the innocent investor -ho had bought these shares much before the scandal -as e+posed.

(! IMPACT ON THE INDIAN ECONOM'


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There -as a lot of media coverage on the scam and the political parties left no opportunity in

criticiing the government for it. The government -as under immense pressure and its

liberaliation policies -ere severely criticied. t -as also believed that 3arshad 'ehta and his

accomplices -ere behind framing of these policies. n the end the government had to put the

liberaliation plans on hold. S/ had to postpone the sanctioning of private sector mutual funds.

mplementation of some aspects of the >arasimham @ommittee recommendations on the

baning system had to be delayed. The much taled about entry of foreign pension funds and

mutual funds became more remote than ever. The /uro9issues planned by several ndian

companies -ere delayed since the ability of ndian companies to raise euity capital in -orld

marets -as severely compromised.

(( IMPACT ON THE "AN4&

6ae ban receipts !R# -hich -ere an integral part of the e+ecution of the -hole scam landed

the bans involved in a tight spot. These R -ere declared void and public money -as at stae.

$t least ten prominent bans -ere involved in thisJ some of them being S, Standard @harteredand a subsidiary of R. The scam could have been checed in time -ith proper policies and

verifications. The government, the R and the commercial bans are as much accountable as

the broers for the scam. The broers -ere encouraged by the bans to divert funds from the

baning system to the stoc maret. The R too stood indicted because despite no-ledge

about bans over9stepping the boundaries demarcating their arena of operations, it failed to

chec them. Some of the prominent individuals -ho -ere penalied -ere I. '. 'argabandhu,

@'C of the E@B an !$rrested and saced# and V. 'ahadevan, one of the 'C the State an

of ndia !Suspended#

(/ RE&PON&E O% THE *O$ERNMENT

$s discussed, the government -as under immense pressure from media and opposition to tae

concrete steps to bring ;ustice to the people and also to ensure that the loopholes in the system

-hich caused such scam -ere closed so that such scams -ould not recur. $s a first step by the

government, the case -as handed over to @entral ureau of nvestigation and the 4oint

Aarliamentary @ommittee !4A@#. Then a special court -as set up to facilitate speedy trial. The

special court declared an ordinance for the attached the properties of all individuals accused in

the scam. 6urther, all transactions done by the accused after 'arch 7%, %&&% -ere considered

void. To reform the system further, the government banned R6 deals and slo-ed do-n the

liberaliation process.

(0 PO)IC' MEA&URE&


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The government, the R and the commercial bans -ere as much accountable as the broers for

this scam. The broers -ere encouraged by the bans to invest their funds in the stoc maret in

place of investing in the baning system. The R -as also responsible for this scam because

despite no-ledge about bans over9stepping the boundaries demarcating their arena of

operations, it failed to reign them in. R didn?t tae any action against the commercial bans.

The looting -as done -ith full no-ledge of the very individuals appointed by the government

-ho -ere responsible to guard against such a possibility. So the 3arshad 'ehta?s scam could

have been detected earlier if either of the above !commercial bans, R or government# parties

not encourage the broers to invest in the stoc maret.

(2 ACTION& TA4EN "' THE *O$ERNMENT:

Discover the guilty

This tas -as assigned to the @entral ureau of nvestigation !@# and to the 4oint

Aarliamentary @ommittee !4A@#. $ special court -as set up to facilitate speedy trial.

Transactions became void

The government set up a special court and promulgated an ordinance -ith several draconian

provisions to deal -ith the scam. Sections !7# and !D# of the ordinance attached the properties of

all individuals accused in the scam and also voided all transactions that had at any stage been

routed through them after 'arch 7%, %&&%.

Recover the money

Arovisions of the Brdinance for attachment of property and voiding of transactions -ith the

conseuent creation of )tainted) shares -ere attempts in this direction

Reform the system

The government*s response so far, banning of R6 deals and going slo- on liberaliation. The

main motive behind punishing the offenders is more to prevent future offenders to not to try this

type of scam. The government must ensure that not only the obviously guilty !the broers# but


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also the not so obviously guilty !the ban e+ecutives, the bureaucrats and perhaps the politicians#

are identified and brought to boo. These types of investigations are not only very time

consuming but also very e+pensive.

3.7 ROL OF !"I #T$I%&L I!!'!(

The S/ -as set up in early %&HH as a non statutory body under an administrative arrangement

and -as subseuently upgraded as a fully autonomous body on %(th of $pril %&&(

The t-o ob;ective s mandated in the S/ $ct are

nvestor protection

Brderly development of capital maret

(5 #UD*EMENT

3e -as later charged -ith 8( criminal offenses and more than :00 civil action suits -ere filed

against him. y the time he died , 'ehta had been convicted in only one of the many cases filed

against him. 3e died in (00( of a massive heart attac in a ;ail in Thane, -ith many litigations

still pending against him.


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CHAPTER I$

CONC)U&ION

@orporate "overnance is the value frame-or, ethical frame-or and moral frame-or -ithin

-hich businesses mae decisions .1hen large sums of money are involved, greed causes people

to become unethical. There -as a total lac of transparency in the money maret. rregularities of

all ind -ere so common that no suspicion aroused even by highly irregular transactions. This is

the ideal environment for a scam to germinate and gro- to alarming proportions. The most

constructive response to the scam -ould be in the arena of reforms of the financial system. n our

vie-, the origins of the scam lie in over9regulation of our marets. The regulations in the money

marets -ere such that thoroughly legitimate and essential transactions could not be put through

openly, but had to be disguised and camouflaged. The role of the broers and of some of the

bans as maret maers -as not recognied and they could perform these important and useful

functions only by subterfuge. The payment and clearance system -as so antiuated and

cumbersome that totally indefensible methods had to be adopted to achieve speedy funds


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transfers. The net result of all these -as a total lac of transparency in the operations in the

money maret. rregularities of all inds -ere so common that no suspicions -ere aroused even

by highly irregular transactions. The situation -as an ideal environment for a scam to germinate

and gro- to alarming proportions. 1e -ould even argue that some of the control systems in the

bans broe do-n because they had been deliberately allo-ed to -eaen by both the commercial

bans as -ell as the R in order to facilitate normal transactions in violation of the R

guidelines.

"I")IO*RAPH'

RE%ERENCE&

K http2FFen.-iipedia.orgF-iiF3arshadL'ehta

K http2FF---.bullrider.inFharshad9mehta9stoc9scamF

K http2FFinvestmentpar.blogspot.comF(008F0(Fharshad9mehta9scam9%&&(.html

K http2FF---.scribd.comFdocF%8((8(%5F3arshad9'ehta9Scam

K http2FF-ii.ans-ers.comFMF@anLyouLgiveLtheLdetailsLaboutLtheL3arshadL'ehtaLsca m


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K http2FF---.authorstream.comFAresentationFpratmL%H9DH:(:89harshad9mehta9and9etan9

pareh9scamF

K http2FF---.slideserve.comFAAT6ilesFinsightsLinvestingL;ul0HL(&5D(L7(D(D.ppt

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Harshad Mehta Case