SHREE DEVI INSTITUTE OF TECHNOLOGY

DEPARTMENT OF BUSINESS ADMINISTRATION

A REPORT ON SCAM 1992

Name of the Student: Ambarish C P

Subject Code and Subject: 21MBA13- Accounting for Managers

Under the Guidance of

Prof. Prateeksha

Assistant Professor
1992 INDIAN STOCK MARKET SCAM

The 1992 Indian stock market scam was a market manipulation carried out by
Harshad Shantilal Mehta with other bankers and politicians on the Bombay Stock Exchange.
The scam caused significant disruption to the stock market of India, defrauding investors of
over ten million USD. Techniques used by Mehta involved having corrupt officials signing
fake cheques, misusing market loopholes, and fabrication to drive the prices of stocks up to
40 times their original price. Stock traders making good returns as a result of the scam were
able to fraudulently obtain unsecured loans from banks. When the scam was discovered in
April 1992, the Indian stock market collapsed, and the same banks suddenly found
themselves holding millions of Indian rupees (INR) in now use less dept

OVERVIEW

The scam was the biggest money market scam ever committed in India, amounting
to approximately ₹ 5,000 crores. The main perpetrator of the scam was a stock and money
market broker Harshad Mehta. It was a systematic stock scam using fake bank receipts and
stamp paper that caused the Indian stock market to crash. The scam exposed the inherent
loopholes of the Indian financial systems and resulted in a completely reformed system of
stock transactions, including an introduction of online security systems. Security frauds refer
to the idea of diversion of funds from the banking system to various stockholders or brokers.
The 1992 scam was a systematic fraud committed by Mehta in the Indian stock market which
led to the complete collapse of security systems. He committed a scam of over 1 billion from
the banking system to buy stocks on the Bombay Stock Exchange. This impacted the entire
exchange system as the security system collapsed and investors lost hundreds of thousands of
rupees in the exchange system.
The scope of the scam was so large that the net value of the stocks was higher
than the combined health and education budget of India. The scam was orchestrated in such a
way that Mehta secured securities from the State Bank of India against forged cheques signed
by corrupt officials and failed to deliver the securities. Mehta made the prices of the stocks
soar high through fictitious practices and sold the stocks that he owned in these companies.
The impact of the scam had many consequences, which included the losses incurred by lakhs
of families and the immediate crash of the stock market. The index fell from 4500 to 2500
representing a loss of ₹ 1000 billion in market capitalization. The 1992 scam raised many
questions involving bank officials responsible for being in collusion with Mehta. An
interview with Montek Singh Ahluwalia revealed that many top bank officials were involved.

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BANK FUNDS SCAM

In the early 70's, banks in India were not allowed to invest in the equity markets.
However, they were expected to post profits and to retain a certain ratio of their assets in
government fixed interest bonds. Mehta squeezed capital out of the banking system to
address this requirement of banks and pumped this money into the share market. He promised
the banks higher rates of interest, while asking them to transfer the money into his personal
account, under the guise of buying securities for them from other banks. At that time, a bank
had to go through a broker to buy securities and forward bonds from other banks. Mehta used
this money temporarily in his account to buy shares, hike up demand of certain shares
dramatically, sell them off, pass on a part of the proceeds to the bank and keep the rest for
himself. This resulted in stocks like ACC, which was trading in 1991 for ₹200/share, catapult
to nearly ₹9,000 in just 3 months.

BANK RECEIPT SCAM

Another major instrument was the bank receipt. 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. The BR serves as a receipt from the selling bank, and also
promises that the buyer will receive the securities they have paid for at the end of the term.
Having figured this out, Mehta needed banks, which could issue fake BRs, or BRs not backed
by any government securities. Once these fake BRs were issued, they were passed on to other
banks and the banks in turn gave money to Mehta, plainly assuming that they were lending
against government securities when this was not really the case. He took the price of ACC
from ₹200 to ₹9,000. That was an increase of 4,400%. Since he had to book profits in the
end, the day he sold was the day when the markets crashed.

READY FORWARD DEAL SCAM

The ready forward deal is a way where a single broker liaisons between two banks. When one
bank wants to sell securities, it approaches the broker. This broker goes to another bank and
tries to sell the securities and vice versa for buying. Since Mehta was a renowned broker, he
got cheques issued in his name instead of the bank.
When the bank wanted money for the securities, he approached another bank and
repeated the same process, and invested the bank money in the stock market. Mehta used the
ready forward deal and applied it to the Bank Receipts system of the Indian financial systems.
This system was the most flawed system as the Janakiraman Committee restructured the
entire Bank Receipts system after the 1992 scam. Mehta used forged BR's to gain unsecured
loans, and used several small banks to issue BRs on demand. Since these banks were small,
Mehta held on to the receipts as long as he wanted. The cheques in favour of both the banks
were credited into the brokers' accounts which was the account of Mehta. As a result, banks
made heavy investments in BOK and MCB as they showed positive signs of growth. Using
the BR scam, Mehta took the price of ACC from ₹200 to ₹9000 in a short span of time. This
4400% percent increase was seen in several other stocks and as he sold the stocks, the market
crashed.
This went on as long as the stock prices kept going up, and no one had a clue
about Mehta's operations. 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 swindled of a
whopping ₹4,000 crore. They knew that they would be accused if their involvement in
issuing cheques to Mehta was discovered. Subsequently, it transpired that Citibank, brokers
like Pallav Sheth and Ajay Kayan, industrialists like Aditya Birla, Hemendra Kothari, a
number of politicians, and the RBI Governor S.Venkitaramanan all had played a role in
allowing or facilitating Mehta's rigging of the share market.

REALIZATION OF SCAM AND MARKET CRASH

The scam first became apparent in late April 1992, when it became
clear that Mehta was a disproportionately large investor in government securities. At the time,
Mehta was doing more than a third of the total securities business in India. When the public
realized that Mehta's investments were illegitimate and that his stocks were likely worthless,
it set off a selling frenzy of Mehta's stocks. The banks that had loaned money to Mehta were
suddenly holding hundreds of millions in unsecured loans. The combination of the selling
frenzy and the fact that numerous banks been defrauded crashed the Indian stock market,
with prices dropping 40% immediately. Stocks eventually dropped 72%, and a bear market
lasted for about 2 years. This table illustrates the extent of money certain banks lost.

IMPACTS
The immediate impact was a drastic fall in share prices and market index, causing a
breakdown of the securities control system operation with the commercial banks and the RBI.
Around ₹35 billion from the ₹2,500 billion market was withdrawn, causing the share market
Impacts collapse. The Bombay Stock shares resorted to records tampering in the trading
system. It caused panic with the public and banks were severely impacted. Banks like
Standard Chartered and ANZ Grindlays were implicated in the scam for bank receipt forgery
and transfer of money into Mehta's personal account.
The government realized that the fundamental problem with the financial structure of
the stock markets was the lack of computerized systems which impacted the whole stock
market. Various bank officers were investigated and implicated in fraudulent charges. The
five main accused officials were related to the Financial Fairgrowth Services Limited and
Andhra Bank Financial Services Ltd. The chairman of Vijaya Bank committed suicide
following the news about the bank receipt scam.
The scam led to the resignation of P. Chidambaram who was accused of owning
shell companies connected to Mehta. Mehta was convicted by the Bombay High Court and
the Supreme Court of India for his part in the financial scandal valued at ₹49.99 billion.
Various bank officials were arrested, leading to a complete breakdown of banking systems

SUBSEQUENT REFORMS
The first reform was the formation of the National Stock Exchange of India (NSE).
It was followed by the development of the CII Code for Desirable Corporate Governance by
Rahul Bajaj. The CII Code commanded the formation of two major committees headed by
Kumar Mangalam Birla and N. R. Narayana Murthy, and overseen by the Securities and
Exchange Board of India (SEBI). The objective was to monitor corporate governance and
prevent future scams. The SEBI were to monitor the NSE and the National Securities
Depository. For the equity market, the government introduced ten acts of parliament and one
constitutional amendment based upon the principles of economic reform and legislative
changes. The introduction of online trading by NSE changed the dynamics of stock buying
and selling. The financial market opened up nationally rather than being confined to Bombay

CHANGES IN THE FINANCIAL STRUCTURE OF INDIA

The 1992 scam collapsed the Indian stock market; around 40% of the market value
or ₹1,000 billion was wiped out. It led the authorities to reconsider existing financial systems
and restructure it. The first structural change was to record payments made for purchasing
investments in reconciled bank receipts and subsidiary general ledgers to prevent fraudulent
transactions. On the advice of the Janakiraman Committee, a committee was established to
oversee the Securities and Exchange Board of India. The primary recommendation of the
committee was to limit ready forward and double ready forward deals to government
securities only. All banks were made custodians rather than principals in transactions. Banks
were to have a separate audit system for portfolios, and it were to be monitored by the
Reserve Bank of India (RBI).