1992 Securities Scam by Harshad Mehta

Who was Harshad Mehta ?

Harshad Mehta was a well known stock broker. His father was a peon. He was born in Rajkot district and migrated to Mumbai. He completed his graduation from Lajpatrai College, in 1976 and worked a no. Of odd jobs for next eight years. In 1984, Mr. Mehta was able to become a member of BSE i.e. Bombay Stock Exchange. Over the years, he rose meteorically to become one of the most influential and powerful brokers on the BSE. Later in his career he was alleged to have manipulated the stock market in 1992 by frequently drawing out huge funds from bank. He had net worth near to $8 billion which he build by using Unscrupulous means. Some financial experts are of the opinion that he didn't commit any kind of fraud, he simply exploited the loopholes in the banking and market system.

What is the Securities Scam ?

The scam of 1991-92 is referred to the Securities Scam. It was a diversion of bank funds worth Rs. 3500 crore to a bunch of stockbrokers - A Bombay based broker, The Kingpin, Harshad Mehta. The funds that were being drawn out were funneled into the share market. This, partly caused the market, Sensex in particular to surge to over 4500 points. It is said, stock like ACC surge from the price of Rs 200 per share to near Rs. 9,000 per share during this time span.

The Two Markets

India had two parallel but different markets in operation. One market deals with corporate securities i.e. the stock exchange. Here the required return on fund was much higher. Also, relatively large number of brokers were present in this market. Even back then in 1992, at least 50 brokers operated in the BSE.

The second market is government securities, on the other hand, had less than a dozen brokers that operated. These brokers were licensed by the RBI. This market was an inter bank market i.e. the buyer and sellers in this market were usually banks. Also, the turnover in this market was close to $ 1 billion per day which was three to four times larger than the stock exchange and at the same time the cost of funds here was half of that on the stock exchange.

The coexistence of these two different markets resulted in rife opportunities for arbitrage. It was only a matter of time that someone would exploit the loopholes in the two markets, and that someone was - Harshad Mehta, The Cunning Broker.

Now let us discuss how was the scam carried out.

Desperation by the Banks

Banks in India, back then, were suffering to make substantial profits because of competing products with better returns like the money market funds and portfolio management services which were offering better returns. Thus, there was a great competition amongst banks for the surplus cash help by the Indian Corporate Sector, Oil and Has PSUs to be particular. This competition and the greed or desire to gain an advantage over competition directed the banks into the schemes of Harshad Mehta.

The Massive Diversion

Harshad Mehta's scheme has a very simple plot. He would embezzle large sums of money from government securities markets secretly, for a short duration. He would then in eat this sum in a selected set of securities and drive their price high. When people start getting excited about a selected security, He would slowly liquidate his part of holdings, pay off the money which was embezzled and pocket the huge difference caused by rising price. The scale of this scam was unimaginable. In an year, he drive the Sensex i.e. the index of the BSE from 1000 to 4500. This kind of unprecedented bull run was never seen in the history of Indian market.

The Modus Operandi

• The main TOOL with the brokers those days was striking RFD i.e. Ready Forward Deals between banks. An RFD is a short term 15 day loan from one bank to another, which is secured. The lending is done against govt. securities. The borrower bank sells the securities to the lending bank and at the end of the tenure, buys them back at a higher price.
• The general settlement process in govt. secs. is that the banks make payments to one another and affect delivery of securities. In this scam, the payment and delivery of securities were made through a set of brokers which means only the brokers would knew the parties on each side.
• The brokers started trading on their own A/c. They pretend that they are undertaking the transaction on behalf of the bank to maintain a fake legality.
• Bank Receipts were used in the lieu of securities by the brokers. So in practicality, only BRs did change hands not the securities. A BR is generally treated as a receipt for money received from the buyer.
• The broker collected with a couple of bank, namely Bank of Karad and Metropolital Co-Operative Bank, which issued fake BRs, which didn't have any security backing. He collects fake BRs from these and passed on to other bank which pay him money under assumption that it was lend against security. This money was flooded in stocks. The shares were sold at profits because of pumped up markets and the BR retired so when it was time to payback money to bank. He struck deals like this across banks and rolled the money at each payout level.

What Happened Next ?

In Nov 1992, Mehta was arrested by investigation agencies. He was charged with over 600 civil suits and 70+ criminal cases relating to cheating , forgery, criminal conspiracy, bribery and falsification of accounts. In 1993, he stirred up a storm when he quoted publically that he had paid bribe of Rs 1 crore to the then PM Narasimha Rao. He was finally found responsible for embezzlement of Rs 1439 crore and a scam leading to loss of wealth of Rs 3542 Crore. On the evening of 31/12/2001, Mehta died at the age of 48 with 27 cases still pending against him.

Author : 

Jay Kumar Hotani