Harshad Mehta Scam — Security Scam of 1992
Why as a common man it becomes important for us to understand the financial scams? The things we do from dusk to dawn relates to our economy in one or the other way. Economy changes with the buying and selling patterns of the citizens, so at the end there is a web between economy and common man activities i.e common man is the backbone of the economy. So, it becomes important for everyone of us to understand about the activities of financial market and how does the whole financial market works. How the financial scams are one of the most disastrous factors for any economy and How the financial scams causes a dis-balance in the economy? Let’s try to understand this Security Scam of 1992 in depth with its impact on Indian Economy and how the stock market faced huge crash because of this.
The 1992 Indian stock market scam is one of the biggest scam ever happened in the Indian Stock Market. In 1992 Scam, Harshad Mehta, Brokers and Banks gamed the entire Indian economic system.
About Harshad Mehta — Biography
Harshad Shantilal Mehta (his full name) was an Indian stock broker, born in a Gujrati Family on 29 July 1954. He spent his early childhood in Kandivali, where his father was a small textile businessman.
He was a cricket enthusiast, and after completing his schooling he came to Mumbai for studies and to find work. He completed his B.Com in 1976 from Lala Lajpatrai College, Mumbai and in the initial years he worked in number of odd jobs related to sales including hosiery, selling cement and diamonds etc. While working as a salesperson in New India Assurance Company Limited (NIACL) he got interest in Stock Market, then he resigned and joined a brokerage firm and to learn more about the stock market he started working as a jobber for the broker Prasann Pranjivandas Broker, whom he considered his “Guru”.
After working for different brokerage firms and gaining experience, Harshad Mehta joined Bombay Stock Exchange (BSE) as a broker by establishing his own consultancy firm “Grow More Research and Asset Management” in 1984. He actively started to trade in 1986. Over these 10 years, by 1990 he gained a prominent position in the stock market. Media and popular magazines like “Business Today” started calling him “Big Bull” and “The Amitabh Bachchan of the stock market”.
His lifestyle included a sea facing 15,000 square feet penthouse in Mumbai’s Worli, with a mini-golf course and swimming pool. Along with all these, he owned expensive luxury cars such as Lexus Starlet (worth Rs 40 Lakh), Toyota Corolla, Toyota Cera and many more fancy cars. All in all, he used to live a luxurious life which people could only dream of.
So Harshad Mehta was a stock broker who became millionaire by manipulating the stock markets in such a way no one have ever done before. Let’s see how he did this.
The Financial Environment of 1990 —
Economic libralization was initiated in India by government in 1991. During this time, the public sector was forced to face the increased competition and was under pressure to display profitability in this new environment of libralization, however private sector responded positively to this change. During this period there was an increase in demand of funds. Due to this the banks were pressured to take advantage of this situation to improve their bottom line, along with this banks were also pressured to maintain profitability. And banks were not allowed to participate in the stock market, so banks were not able to enjoy the benefits of stock market during the period of 1991.
Financial Terms Related to Security Scam 1992 —
Before we talk about the actual scam, it will be helpful for us to understand the scam in more detail if we get to know about some of the financial terms, specific to Scam 1992.
- Statutory Liquidity Ratio (SLR) — It’s mandatory for the banks to maintain a certain thershold (in 1990’s it was set to 38.5%) of government fixed interest bonds. This minimum percentage of government bonds which banks have to maintain is called Statutory Liquidity Ratio (SLR).
- Ready Forward (RF) Deal — is a secured short term loan (15 days to one month) from one bank to another bank. In this deal, the collateral is government bonds.
- Bank Receipt (BR) — The borrowing bank instead of actually giving the securities (the government bonds) gave a BR which was proof that the money is received and in case of default the securities will be given. So BR is a kind of “I Owe You (IOU)” receipts.
- Why BR, Not the Securities — Because the bond certificated held by the bank would be of bonds worth 100 Crore, whereas the requirements of the banks to maintain their SLR ratio would be lower. Thay is why BR’s were much more convenient way of short term transfer. BR’s were used so that the actual transfer of the securities does not take place, BR’s could simply be cancelled and returned once the deal was completed.
- Settlement Cycle — Is the time within which brokers have to pay full money and take delivery of stocks or deliver stocks if sold.
The government issue bonds with the aim of developing the infrastructure of the country, the big development projects which are taken up by the government are financed through these bonds.
Roles played by Brokers —
Brokers in the market played the role of intermediaries between two banks in the RF Deal system, by helping borrowing banks meet lending banks. The actual exchange of the securities and payments should have taken place only between the banks, but Brokers soon found a way to play a larger role. And eventually all the transfer of securities and payments were made to brokers, and banks also wecomed this because of the following reasons :-
- Liquidity as brokers provided quicker and easier alternative in comparsion to dealing with another bank.
- Secrecy as lending banks were not aware about to where the loans are being moved to and the borrowing banks were not concerned about from where the loans are coming from.
- Credit Worthiness as brokers were handling the settlement process which benefitted the borrowing banks as they can have loans available regardless of their credit worthiness.
The loans were viewed as loans to the brokers and loans from the brokers.
Role played by Harshad Mehta — How Harshad Mehta did Security Scam?
Harshad Mehta convienced the banks to draw the checks in his name. He then managed to transfer the money deposited in his account into the stock markets. Harshad Mehta took the advantage of the broken system and took the scam to the next levels.
Normally, in a RF deal there would be only two banks involved. What Harshad Mehta did here was that when a bank requested for its securities or cash back, he started to reach out to new bank, and eventually third bank, forth bank and so on.
Instead of having just two banks involved, there were now a lots of multiple banks involved and all were connected by a web of RF deals.
How Harshad Mehta did Security Scam ? — More About the Scam
Harshad Mehta used the money which he got from the banks to combat with the bear cartels in the stock marke. Bear Cartels were also operating the stock market with money that hey cheated out from the banks to drive the market downside to undervalue the stocks and securities. Counter to this Harshad Mehta was pumping money from the banks which was temporarily in his account, into the stock market to keep the demand high in market. He was having such a influence in the stock market that his words were blindly followed.
Some of the popular stock manipulated by Harshad Mehta —
As Harshad Mehta was investing money from the banks into the stock market, where he manipulated shares of some companies like ACC, Videocon, Sterlite Industries and just brought these companies shares to hike up the demand dramatically. He then used to sell those shares and returns the money to the banks and keeps the profit with himself.
The price of ACC rose from Rs. 200 to nearly Rs. 9000 in span of 3months. Some other stocks were —
He invested in different companies such as ACC, Apollo Tyres, Reliance, Hero Honda, Tata Iron and Steel Co (TISCO), BPL, Sterlite and Videocon, which resulted in dramatic rise in Sensex. In the period between April 1991 to April 1992, the Sensex returned 274 percent, moving from 1194 points to 4467, that is the highest anual return of the index.
Benefits to Banks — Were Banks Aware ?
The banks were aware of Harshad Mehta’s actions but banks chose to keep silence as they too were getting benefit from the profit which Harshad Mehta was making from the stock market, which was helping banks to maintain profitability.
The Scam within the Scam —
1. Fake BR Scam — Mehta perfected the art of using fake BR’s to obtain unsecured loans from the banking system, as he noticed it very early the dependency of RF Deals on BR’s. To get the fake BR’s he presuaded some small and little known banks like The Bank of Karad (BOK) and The Metropolitan Cooperative Bank (MCB), to issue the BR as and when required. With the help of these two banks he was able to forge the the BR’s which were not backed by any securities — menas they were just piece of papers with no real value. And he further pumped all this money into the stock market.
2. Fake Government Bonds — Also to eliminate the collateral he forged government bonds themselves. However this forgery amounted for a very small amount of funds misappropriated.
Who exposed Harshad Mehta Scam ?
Journalist Sucheta Dalal exposed the scam on 23rd April 1992 in the columns of Times of India. Also in the inspections and audit conducted by RBI revealed that the amount represented by BR in circulation was significantly higher than the government bonds actually held by the banks. Sucheta Dalal got interested after she saw him driving up at State Bank of India offices. Also the bear cartel ganged up on Mehta blew the whistle on him to get rid of him and the bullish run.
The scam’s exposure led to the suicide of the chairman of Vijya Bank who issued check to Mehta. Harshad Mehta was convicted by the Bombay High Court and the Supreme Court of India for his part in this financial scandal valued at Rs 5000 crore, (USD $ 740 million).
After the exposure of this scam, the stock market was crashed and most of the investors lost their money. Also banks asked Harshad for their money back, but because of the Bear run, Harshad could not return their money back. Securities and Exchange Board of India (SEBI) even banned him from permanent trading in stock market.
After the scam was exposed, Harshad Mehta was arrested by the Central Bureau of Investigation (CBI) in November 1992. He was charged with 600 civil action suirts and 70 criminal cases. After 3 months in jail, he was released (his case was handled by lawyer Ram Jethmalani) but in 1997 he was again arrested and had been put in Thane jail.
On 31, December 2001, when everyone was celebrating the Happy New Year, he complained of pain in his chest pain and was admitted to Thane Civil Hospital. But he lost the fight against life and died. Before his death, out of 27 criminal cases, he was only convicted of four cases.
Also there is a book written by Sucheta Dalal in the market with name The Scam : Who won, Who Lost, Who Got Away
Link to get the Book — https://amzn.to/3f8a5XR
How Harshad Mehta Scam changed Dalal Street ?
The scandal exposed the loopholes in the Indian Banking System, Bombay Stock Exchange (BSE) transaction system and SEBI further introduced new rules to cover these loopholes.
Harshad Mehta changed the way one looks at the stock market and how brokers trade and following the fraud, the Securities Laws (Amendments) Act was passed in 1995, which widened the jurisdiction of the Securities and Exchange Board of India. It allowed SEBI to regulate depositories, FIIs, venture capital funds, and credit rating agencies.
Here are five ways the Indian stock markets have changed since 1992 Scam —
Settlement Cycle — In 1992 the cycle was 14 days. Now, it is two days, and SEBI is hinting at a 1-day cycle soon.
Minimum Balance — In 1992, there was no rule over maintaining the minimum balance in account that a customer needs to ensure to buy stocks. Now, a customer can’t buy stocks without the minimum balance in the account or sell without stocks in their Demat account.
Trading Process — Before 1992, all the trades were placed through dealers on papers in which there was a huge execution risk. Now, customers are executing their trades on their own.
Settlement of Trades — Before 1992, settlement of trades was done through paper, making counter-party risk evident. Now, all transactions are electronic and all settlement of trades happens through clearing corporations only.
Brokerage Fee — In 1992, customers paid at least 1 percent as brokerage for equity delivery trades. No brokerage charges are levied now.
Top lessons from Harshad Mehta Scam to all Traders and Investors —
- Reaearching and the art of selling are the never fading skills in business.
- People generally makes mistakes when guided by emotions.
- Greed digs its own grave.
- Learning anything is possible if one really wants.
- When everyone is busy in the game, keep an eye in the field.
- The biggest risk is in not taking the risk.
- Always have patience in life and stock market as well.
- Never ever Invest your money in stock market by lending money or by loan or by promising assured returns . Stock Market can do anything at anytime !!
- STOCK MARKET can also be called as SHOCK MARKET because It can surprise you anytime and you should better be prepared to face it better.
- In life Always look for Long term decisions to make money.
— Source sharesansar and cofounderstown
Closing Thoughts —
The Harshad Mehta scam can be looked at from two angles. The first is the scam where Harshad Mehta looted stock market, banks and public or the second is Harshad Mehta was made the victim as someone had to be blamed and at the same time kept other influential people away from the limelight. Also some financial experts still believe that Harshad did not commit any fraud, “he simply exploited loopholes in the system”.
To learn more about the stock market, I will recommend my readers to read “The Intelligent Investor” by Benjamin Graham.
A web series Scam 1992 — The Harshad Mehta Story produced by Applause Entertainment is based on his life. It is currently available in SonyLIV.
My Story — How I learned value investing and get into Stock Market?
Being an Engineering graduate, just after the graduation when I joined my first job as Software Engineer, get into stock market for investing money because money sitting in cash will lose its value over time. In the beginning to get the knowledge of stock market and to get into it, read a lots of good books on value investing which helped me a lot to manage my portfolio on my own. Here is the list of Top 10 best value investing books for stock market investors.
Top 10 best value investing books for stock market investors —
- Rich Dad and Poor Dad by Robert T. Kiyosaki — Talks about lessons which rich folks teach their kids about money. Poor folks should also teach their kids.
— Kindle Edition of this Book is — Rich Dad and Poor Dad - The Little Book That Beats the Market by Joel Greenblatt — Shortest Book on value investing and approach to pick winning stocks.
— Kindle Edition of this Book is — The Little Book That Beats the Market - The Dhandho Investor by Mohnish Pabrai — Most Simple and influential book that I have ever read, talks about low risk, high return.
— Kindle Edition of this Book is — The Dhandho Investor - Value Investing and Behavioral Finance by Parag Parikh — Educates much needed topics that are ignored by most finance websites, books and media.
— Kindle Edition of this Book is — Value Investing and Behavioral Finance - The Intelligent Investor by Benjamin Graham — By far the best book on investing ever written, guru of Warren Buffett.
— Kindle Edition of this Book is — The Intelligent Investor - Security Analysis by Benjamin Graham — Foundation of Value Investing and then proceeds to explain how to apply it across all asset classes.
— Kindle Edition of this Book is — Security Analysis - Warren Buffett Letters to Shareholders by Warren Buffett — This is not exactly a book but a collection of letters written by Warren Buffett to his sharegolders at Berkshire Hathaway.
— Kindle Edition of this Book is — Warren Buffett Letters to Shareholders - Common Stocks and Uncommon Profits by Philip A. Fisher — Ideas of analyzing stock based on their growth potential.
— Kindle Edition of this Book is — Common Stocks and Uncommon Profits - Stocks for the Long Run by Jeremy Siegel — Explains the concepts of Investing in stocks over the long haul.
— Kindle Edition of this Book is — Stocks for the Long Run - How to Make Money in Stocks by William J. O’Neil — Explains CAN SLIM system of choosing stocks.
— Kindle Edition of this Book is — How to Make Money in Stocks
I hope you enjoyed reading the story or Harshad Mehta and Its Scam.
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