HARSHAD MEHTA SCAM,1992

HARSHAD MEHTA-Darling of Business Media

Big BullStock Market Guru Stock Market Success Story of Rags to Riches

Overview :An Indian Stock Broker .Indias best known scamster.Charged with 72 criminal offences.More than 600 civil action suits filed against him.Died in 2002 due to chest pain.

History Of Harshad Mehta Harshad Shantilal Mehta He was born in a Gujarati Jain Family in Raipur and his father was Shantilal Mehta and mother was Rasilaben Mehta.He studied at the Holy Cross High School, located at Byron Bazaar in Raipur.Then his family shifted to Bombay, Supporting himself with odd jobs he completed a Bachelors degree in Commerce in 1965 from Lala Lajpat Rai College .

Cont(d).He started his working life as an employee of the New India Assurance Company. His brother Ashwin Mehta pursued his graduation course in law at Lala Lajpat Rai College and his youngest brother Hitesh was a surgeon at the B.Y.L.Nair Hospital in Mumbai .Ashwin and Hitesh were involved in Scam along with Harshad.In the early eighties he quit his job and sought a job with stock broker P. Ambalal (who is affiliated to Bombay Stock Exchange BSE ).

Cont(d)..In 1981 he became a sub-broker for stock brokers J.L. Shah and Nandalal Seth.

As a stock broker ,every evening Harshad and Ashwin started to analyze tips generated from respective offices and to clearly understand the stock market operations and they extended their study to regular financial statements as well. His brother quit his job to team with him to start their venture Grow More Research and Asset Management Company Limited.

Cont(d)He felt proud of his accomplishments and showed off his success to journalists through his mansion "Madhuli",15000 square feet house, which included a billiards room, mini theatre ,swimming pool as well as a golf patch. His brand new fleet of cars gave credibility to his show off.He lived almost like a movie star.

During his heyday, in the early 1990s, Harshad Mehta commanded a large resource of funds and finances as well as personal wealth.

Mechanism of Scam: Being hailed as a financial wizard and trusted by hundreds of players in financial markets was quite an achievement for a man who barely scraped through his Bachelor of Commerce with just 36%. Harshad Mehta was an Indian stock broker and is alleged to have engineered the rise in the BSE stock exchange in the year 1992. Mehta was making waves in the stock market. He had been buying shares heavily since the beginning of 1990. The shares which attracted his attention were : ACC (Associated Cement Company) Apollo Tyres Reliance Tata Iron and Steel Co. (TISCO) BPL Sterlite Videocon.

Ready Forward(RF) Deal:The crucial mechanism through which the scam was effected was the ready forward (RF) deal. The RF is in essence a secured short-term (typically 15-day) loan from one bank to another. The bank lends against government securities just as a pawn broker(a person licensed to lend money) lends against jewellery.The borrowing bank actually sells the securities to the lending bank and buys them back at the end of the period of the loan, typically at a slightly higher price.It was this ready forward deal that Harshad Mehta used with great success to channel money from the banking system. A typical ready forward deal involved two banks brought together by a broker in lieu of a commission. The broker handles neither the cash nor the securities.

Settlement Process of RF Deal:In this settlement process, deliveries of securities and payments were made through the broker. That is, the seller handed over the securities to the broker, who passed them to the buyer, while the buyer gave the cheque to the broker, who then made the payment to the seller.

The buyer and the seller might not even know whom they had traded with, either being know only to the broker.

The brokers could manage primarily because by now they had become market makers and had started trading on their account. To keep up a semblance of legality, they pretended to be undertaking the transactions on behalf of a bank.

Bank Receipts:Another instrument used in a big way was the bank receipt (BR). In a ready forward deal, securities were not moved back and forth in actuality. Instead, the borrower, i.e. the seller of securities, gave the buyer of the securities a BR. A Bank Receipt (BR) confirms the sale of securities. It acts as a receipt for the money received by the selling bank. Hence the name - bank receipt. It promises to deliver the securities to the buyer. It also states that in the mean time, the seller holds the securities in trust of the buyer. Having figured this out, Mehta needed banks, which could issue fake BRs, or BRs not backed by any government securities. Two small and little known banks - the Bank of Karad (BOK) and the Metropolitan Co-operative Bank (MCB) - came in handy for this purpose. These banks were willing to issue BRs as and when required, for a fee.

Cont(d).

Once these fake BRs were issued, they were passed on to other banks and the banks in turn gave money to Mehta, obviously assuming that they were lending against government securities when this was not really the case. This money was used to drive up the prices of stocks in the stock market. When time came to return the money, the shares were sold for a profit and the BR was retired. The money due to the bank was returned. The game went on as long as the stock prices kept going up, and no one had a clue about Mehtas modus operation. Once the scam was exposed, though, a lot of banks were left holding BRs which did not have any value - the banking system had been double cross of a whopping Rs 4,000 crore.

Coupon Changes and insider trading During the period from September 1991 to June 1992, the government raised the interest (Coupon) rate on its fresh borrowing three times. The major implication of raising interest rate on new borrowings is that it would trigger a fall in the market prices of the old loans which are pegged at the old (lower) interest rates. The price of the 11.5% Government Loan 2010 dropped by 3% to 5% with each coupon rate hike. If anyone has advance information about these changes in the coupon rates, he could make enormous amounts of risk less profit by short selling the old securities just before the announcement of rate hike. Harshad Mehta make manipulations at this side also.

Stock Market ScamLater, firms have only to take permission of Controller of Capital Issues (CCI) under the Capital Issues (Control) Act for raising capital and fixing the premium on the issue price. Harshad Mehta again with his big approach and mind influencing premium and issue prices and make short selling accordingly to get big benefits. The absence of a proper regulatory framework and the failure of SEBI to monitor and supervise the flood of IPO's and FIIs, led to a massive scam in the primary market. A lot of fake companies are formed which rob the money of unsuspecting investors by making manipulations in prices of false stocks. Harshad also was involved in formation of such companies.

Main victims of Scam:In April 1992, news broke that State Bank of India had asked Mehta to return Rs.500 crores he had illegally put to work on the stock markets.

By the end of that month, he was accused of having diverted funds from the public sector Maruti Udyog Limited (MUL) to his own accounts, provoking a record 570-point fall in the Sensex. Considering the case of the MUL fraud,in one operation, for example, an MUL employee handed over 35 lakh Unit Trust of India (UTI) units, then valued at Rs.4.99 crores, to Mehta's New Delhi manager, Mohan Khandelwal, on January 23, 1991. The transfer was made in violation of the express orders of MUL's board of directors.

Cont(d). ANZ Grindlays bank's (now Standard Chartered Grindlays) Ram Narayan Popli was another key player in the Mehta game. On one occasion in February 1991, he diverted a Canara Bank banker's cheque worth Rs.5.05 crores favouring Grindlays Bank to Mehta's account. On March 18 and April 24 that year, he pulled off the same trick, this time with banker's cheques worth Rs.10.84 crores and Rs.7.62 crores. Thus, MUL was not Mehta's only victim. Both UCO Bank and ANZ Grindlays suffered separately.

From then until June 1992, when a Parliament led to the formation of a Joint Parliamentary Committee (JPC) to investigate the matter. While the JPC Report soon provided a comprehensive and coherent picture of both the scale and mechanics of the securities fraud.It was only in October 1997 the Central Bureau of Investigation (CBI) in all filed 72 sets of charges relating to criminal offences, while 600-odd civil cases proceeded alongside.

Exposure of Harshad Mehta:On April 23, 1992, journalist Sucheta Dalal in a column in The Times of India, exposed the dubious ways of Harshad Mehta that the broker was dipping illegally into the banking system to finance his buying.

Impact of 1992 Scam

The Harshad Mehta induced security scam, as the media sometimes termed it, adversely affected at least 10 major commercial banks of India, a number of foreign banks operating in India, and the National Housing Bank, a subsidiary of the Reserve Bank of India, which is the Central Bank of India.A number of people holding key positions in the India's financial sector were adversely affected, which included arrest and sacking of K. M. Margabandhu, then CMD of the UCO Bank; removal from office of V. Mahadevan, one of the Managing Directors of Indias largest bank, the State Bank of India.

After the Scandal:Charismatic, ebullient and recklessly ambitious, Harshad Mehta set out to be a role model for investors. "I thought I am like Pied Piper", he had told a newspaper in 1992, "I thought I can sell dreams... that asset-creation is not a crime, that if you wanted to be Harshad Mehta come to the stock market". For a few months after the scam in June 1992 he was released after 107 days in custody within weeks after his release he was hogging headlines as the first man ever to claim that he had bribed a sitting Prime Minister and he had paid Rs 1 crore to the then Congress President and Prime Minister, Mr P.V. Narasimha Rao, as donation to the party for getting him ``off the hook.''

That too was done in typical Harshad fashion - press conferences at the Taj and the Oberoi, high profile lawyers, the release of audiotapes and the demonstration of Rs 10 million being stuffed into a large suitcase.He was willing to revel even in negative publicity at that point of time.Mehta made a brief comeback as a stock market guru, giving tips on his own website as well as a weekly newspaper column. This time around, he was in cahoots with owners of a few companies and recommended only those shares. This game, too, did not last long.

Fate of Harshad Mehta

Market watchdog, Securities and Exchange Board of India, had recently banned him for life from stock market-related activities. Mr Mehta perhaps had as many admirers as critics. But almost all of them admit that he caused a ``change'' in the Indian stock market, permanently.

He not only looked defeated but sources close to him say that he was steadily running out of funds. Most of this was probably due to the realization that with one conviction by the Special Court and another by SEBI, his dreams of coming back to the capital market had ended forever. Now it is truly over.

His ``bull'' run, however, ended in April 1992 when the stock market scam broke out bringing down in its wake several financial entities and causing despair to millions of investors.. He was arrested and banished from the stock market with investigators holding him responsible for causing a loss of more than Rs 4,000 crore to various entities.

Cont(d)..

During his judicial custody, while he was in Thane Prison, Mumbai, he complained of chest pain, and was moved to a hospital, where he died on31,December,2001.His death remains a mystery. Some believe that he was murdered ruthlessly by an underworld nexus (spanning several South Asian countries including Pakistan). Thus came to an end the life of a man who is probably the most famous character ever to have emerged from the Indian stock market. Harshad Mehta pulled off one of the most audacious scams in the history of the Indian stock market. The death at the Thane Civil Hospital of the architect of the Rs. 4,000-crore 1992 securities scandal has effected final closure on the legal proceedings against him. He died with many litigations still pending against him and died at the age of 47 years.

REFORMS AFTER SCANDALSEBI was established in 1992. Before the reforms, under the Capital Issues (Control) Act, firms were required to obtain approval from the Controller of Capital Issues (CCI) for raising capital and fixing the premium on the issue price. This Act was repealed in 1992 and statutory control on floatation and pricing of issues was abolished, subject only to certain disclosure requirements. While SEBI enacted certain disclosure requirements, events have shown that it was not able to enforce them. There have been too many cases of price rigging by companies before public issues, managing often to fix exorbitant premia and take the investors for a ride.

The other half of the scam had a multitude of small traders, chartered accountants and businessmen, who teamed up with bankers and investment companies to float new companies and raise public funds. Government promise to trace the fly-by-night operators who had duped the shareholders and bring them to books.

The major weaknesses of the secondary market, pre-reform, included lack of transparency, speculative excesses and scant regard for the interests of small investors. Large volumes of trade were executed outside the exchanges after the trading hours; brokers did not distinguish between personal and client accounts; deals were not time-stamped; brokers contracts did not clearly separate price, commission and carry-forward charges. There was a significant amount of insider-trading. So, the National Stock Exchange (NSE) was established with the explicit aim of moving rapidly to nation-wide screen-based trading. The NSE began operations in 1994 and soon acquired a reputation for transparency.

A great deal of energy has been spent in the long-drawn battles over badla, the century-old trading arrangement to carry the contract forward with the help of intermediary financiers. SEBI banned badla in December 1993 on the ground that it suffered from many shortcomings as regards both investor protection and systemic risk. The latest move to introduce margin trading as an alternative financing mechanism. the RBI has said that banks financing margin trading must ensure that no `nexus develops between inter-connecting broking entities/stock brokers and banks.

In October 1995, an ordinance was passed providing for the establishment of one or more depositories to take away the arbitrary power of company managements to block the transfer of shares. The National Securities Depository Limited (NSDL) commenced operations in October 1996 The second depository, the Central Depository Services (India) Ltd (CDSL), was granted certificate of registration in 1998 . Also, over the past three years, SEBI has taken initiatives to progressively promote dematerialized or paperless trading. Based on a SEBI committee recommendation, the BSE and the NSE have also allowed their brokers recently to start Internet-based trading.

Now, the SEBI has introduced a new reform after above scam i.e. there is a limit for securities if the price of a particular security goes up the limit, that security will be freezed and if goes down it should suspend from stock exchange i.e. filtering.

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