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    Harshad Mehta Scam

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    Kriti Shah
    Harshad Mehta was an Indian stockbroker who engineered a stock market scam in 1992 by exploiting loopholes in the banking system. He took advantage of rules that allowed banks to delay reporting their bond holdings, acting as an intermediary to siphon funds from banks to invest in stocks and artificially inflate prices. Mehta used illegal practices like issuing fake bank receipts to obtain loans secured by nonexistent bonds. The scam was exposed by a journalist and led to a sharp drop in stock prices, hurting many investors. In response, regulations were strengthened including conferring statutory powers to SEBI and imposing new margin requirements and restrictions on trading.

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    Harshad Mehta Scam

    Uploaded by

    Kriti Shah
    209 views5 pages
    Harshad Mehta was an Indian stockbroker who engineered a stock market scam in 1992 by exploiting loopholes in the banking system. He took advantage of rules that allowed banks to delay reporting their bond holdings, acting as an intermediary to siphon funds from banks to invest in stocks and artificially inflate prices. Mehta used illegal practices like issuing fake bank receipts to obtain loans secured by nonexistent bonds. The scam was exposed by a journalist and led to a sharp drop in stock prices, hurting many investors. In response, regulations were strengthened including conferring statutory powers to SEBI and imposing new margin requirements and restrictions on trading.

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    Harshad Mehta was an Indian stockbroker who engineered a stock market scam in 1992 by exploiting loopholes in the banking system. He took advantage of rules that allowed banks to delay reporting their bond holdings, acting as an intermediary to siphon funds from banks to invest in stocks and artificially inflate prices. Mehta used illegal practices like issuing fake bank receipts to obtain loans secured by nonexistent bonds. The scam was exposed by a journalist and led to a sharp drop in stock prices, hurting many investors. In response, regulations were strengthened including conferring statutory powers to SEBI and imposing new margin requirements and restrictions on trading.

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    © All Rights Reserved
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    Download as docx, pdf, or txt
    209 views5 pages

    Harshad Mehta Scam

    Uploaded by

    Kriti Shah
    Harshad Mehta was an Indian stockbroker who engineered a stock market scam in 1992 by exploiting loopholes in the banking system. He took advantage of rules that allowed banks to delay reporting their bond holdings, acting as an intermediary to siphon funds from banks to invest in stocks and artificially inflate prices. Mehta used illegal practices like issuing fake bank receipts to obtain loans secured by nonexistent bonds. The scam was exposed by a journalist and led to a sharp drop in stock prices, hurting many investors. In response, regulations were strengthened including conferring statutory powers to SEBI and imposing new margin requirements and restrictions on trading.

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    HARSHAD MEHTA SCAM

    REPORT

    - Team Morgan Stanley


    Group-24

    ABOUT HARSHAD MEHTA AND THE SCAM


    Harshad Mehta was an Indian Stockbroker and is alleged to have engineered the rise in the BSE
    stock exchange in the year 1992. He promised the ultimate rags to riches story -- from the small
    town Raipur boy who was once rusticated from school to Sultan of Dalal Street with all the
    trappings of wealth such as a fabulous house, a fleet of cars and multiple stock exchange
    memberships
    Mehta was born in a middle class Gujrati family, and spent his childhood in Mumbai where his
    father was a small businessman. Later, the family moved to Raipur, Madhya Pradesh after
    doctors advised his father to move to a drier place. Having completed his studies, he came back
    to Mumbai to start working with well-known stockbrokers of BSE. Having gained experience as
    a sub-broker, he teamed up with is brother for a new venture. His ex-employers helped him get
    the brokers card in the BSE.
    By 1990, he had made a big name in the stock market. He started buying shares heavily. He was
    so attracted to the shares of Indias most prominent cement manufacturer Associated Cement
    Company (ACC) that he took the price of the company from 200-9000 (approx.). When asked
    for the reason for this high level bidding, he told that older companies should be valued on the
    basis of the amount of money that should be needed to create another such company.
    Mehta was accused of manipulating the rise in the Bombay Stock Exchange. He took advantage
    of the many loopholes in the banking system and drained off funds from inter-bank transactions.
    In the early 1990s, the bank had to maintain some particular amount of deposits in bonds. This
    ratio was known as the Statutory Liquidity Ratio (SLR). Each bank had to submit its balance
    sheet at the end of the day. Now, the government decided that banks need to show their balance
    sheet only on Fridays. This meant that the banks would sell the bonds in the earlier parts of the
    week and buy them back towards the end of the week. Now at the end of the week many banks
    are desperate to buy bonds back. There comes the role of a broker. The brokers knew which bank
    had bonds in excess and which had less than the requires amount. He acts as a middleman for the
    banks. Harshad Mehta was one such broker who exploited this loophole.
    Now what Harshad Mehta did was that he told the banker at A Bank that he was dealing with
    many banks and hence did not know who he would deal in the end with. So he said that the bank
    should write the cheque in his name rather than the other bank (which was forbidden by law), so
    that he could make the payment to whichever bank was required. Since he was a trusted broker,
    the banks agreed. Then, going back to the example of bank A and B, he took the money from A
    and went to B and said that he would pay the money on the next day to B but he needed the
    bonds right now (for A). But he offered a 15 % return for bank B for the one day extension. Bank
    B readily agreed with this since it was getting such a nice return. Now since Harshad Mehta was
    dealing with many banks at the same time he could then keep some capital with him at all times.
    For example, he takes money from A on Monday, and tells B that hell pay on Tuesday, then he
    takes money from C on Tuesday and tells D that hell pay on Wednesday and the money he gets
    2

    from C is paid to B and as a result he has some working capital with him at all times if this goes
    on with other banks throughout the week. The banks at that time were not allowed to invest in
    the equity markets. Harshad Mehta had very cleverly squeezed some capital out of the banking
    system. This capital he invested in the stock market and managed to stoke a massive boom. This
    is actually how he got funds to buy the shares of ACC.

    INSTRUMENTS USED IN SCAM


    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
    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
    Mehta and his accomplices used with great success to channel money from the banking system.
    In a ready-forward deal, a broker usually brings together two banks for which he is paid a
    commission. Although the broker does not handle the cash or the securities, this was not the case
    in the prelude to the Mehta scam.
    The securities and payments were delivered through the broker in the settlement process. The
    broker functioned as an intermediary who received the securities from the seller and handed
    them over to the buyer; and he received the check from the buyer and subsequently made the
    payment to the seller. Such a settlement process meant that both the buyer and the seller may not
    even know the identity of the other as only the broker knew both of them. The brokers could
    manage this method expertly as they had already become market makers by then and had started
    trading on their account. They pretended to be undertaking the transactions on behalf of a bank to
    maintain a faade of legality.

    Mehta and his associates used another instrument called the bank receipt (BR). Securities were
    not traded in reality like in a ready forward deal but the seller gave the buyer a BR which is a
    confirmation of the sale of securities. A BR is a receipt for the money received by the selling
    bank and pledges to deliver the securities to the buyer. In the meantime, the securities are held in
    the sellers trust by the buyer.
    Prepared with their evil mind, Mehta needed now banks which would readily issue fake BRs, or
    ones without the guarantee of any government securities. His search ended when he found that
    the Bank of Karad (BOK), Mumbai and the Metropolitan Co-operative Bank (MCB) two small
    and little known lenders, were willing to comply. The two banks agreed to issue BRs as and
    when required. Once they issued the fake BRs, Mehta passed them on to other banks who in turn
    lent him money, under the false assumption that they were lending against government securities.
    Mehta used the money thus secured to enhance share prices in the stock market. The shares were
    then sold for significant profits and the BR retired when it was time to return the money to the
    bank.

    EXPOSURE OF THE SCAM


    In April 1992, the first press report appeared indicating that there was a shortfall in the
    Government Securities held by the State Bank of India. In a little over a month, investigations
    revealed that this was just the tip of an iceberg which came to be called the securities scam,
    involving misappropriation of funds to the tune of over Rs. 3,500-4,000 crores.
    But the scams link to the culprits was actually exposed by journalist Sucheta Dalal on 23 April
    1992. She exposed Mehtas illegal methods of how he was dipping illegally into the banking
    system to finance his buying, in a column in The Times of India. She then investigated the Ketan
    Parekh case and found its similarities to the Harshad Mehta case.

    IMPACT ON STOCK MARKET AND ECONOMY

    The immediate impact of the scam was a sharp fall in the share prices. The index fell
    from 4500 to 2500 representing a loss of Rs. 100,000 crores in market capitalization.
    Since the accused were active brokers in the stock markets, the number of shares which
    had passed through their hands in the last one year was colossal. All these shares became
    tainted shares, and overnight they became worthless pieces of paper as they could not
    be delivered in the market. Genuine investors who had bought these shares well before
    the scam came to light and even got them registered in their names found themselves
    being robbed by the government. This resulted in a chaotic situation in the market since
    no one was certain as to which shares were tainted and which were not.
    The governments liberalization policies came under severe criticism after the scam, with
    Harshad Mehta and others being described as the products of these policies.
    Bowing to the political pressures and the bad press it received during the scam, the
    liberalization policies were put on hold for a while by the government. The Securities
    Exchange Board of India (SEBI) postponed sanctioning of private sector mutual funds.
    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.

    POST SCAM REGULATIONS

    Post Mehta Scam in 1992, the GoI passed SEBI Act 1992 and conferred statutory
    powers to it
    MEASURES TAKEN:
    Imposed an additional 10% volatility margin on A Group shares as well as margins on
    ALBM and BLESS Schemes
    Imposed volatility margins on net outstanding sale positions of FIIs, financial institutions,
    banks and mutual funds
    Banned naked short sales in March 2001

    Reduced the gross exposure limit for brokers to 10 times the base capital for NSE and 15
    times for other stock exchanges
    Rolling settlements system made compulsory
    Allowed banks to offer collateralized lending only through BSE & NSE, to increase
    liquidity
    Launched trade guarantee fund to guarantee all transactions

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