Report on Harsad Mehta Scam, Security Scam

1. Report
on
Harsad Mehta Scam
Date: 30th January’14
Assignment: 1st
Teacher: Mr. Y.G Reddy
Submitted By:
Nigam Raj
BBA 2nd year

2. Content
Biography
1992 Security scam
Exposure
BreakDown of Scam
Impact of Scam
News Paper Article (TOI)
Refrence

3. Biography
Harshad M Mehtawas an Indian stockbroker, well known for his wealth and for
having been charged with numerous financial crimes that took place in 1992. Of
the 27 criminal charges brought against him, he was only convicted of one, before
his death at age 47 in 2001. It was alleged that Mehta engaged in a massive stock
manipulation scheme financed by worthless bank receipts, which his firm
brokered in "ready forward" transactions between banks. Mehta was convicted
by the Bombay High Court and Supreme Court of India[2] for his part in a financial
scandal valued at 4999 crore (US$800 million) which took place on the Bombay
Stock Exchange (BSE). In reality he actually exposed the loopholes in the Bombay

4. Stock Exchange (BSE) transaction system and SEBI further introduced new rules to
cover those loopholes. He was tried for 9 years, until he died in the late 2001.
Mehta was under Criminal custody in the Thane prison. Mehta complained of
chest pain late at night and was admitted to the Thane civil Hospital. He died
following a brief heart ailment, at the age of 47, on 31 of December 2001. He is
survived by his wife and one son.[11] He died with many litigations still pending
against him. He had altogether 28 cases registered against him. The trial of all
except one, are still continuing in various courts in the country. Market watchdog,
Securities and Exchange Board of India, had banned him for life from stock
market-related activities.

5. 1992 Security Scam
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,
though that wasn’t the case in the lead-up to the scam. 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. In this settlement process, the buyer and the seller might not even
know whom they had traded with, either being known only to the broker. This 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.
 The Ready Forward Deal (RF) is in essence a secured short term (typically 15
day) loan from one bank to another bank. The lending is done against
Government Securities exactly the way a pawnbroker lends against jewelry.
 In fact one can say that the borrowing bank actually sells the securities to
the lending bank and buys them back at the end of the period of the loan at
(typically) a slightly higher price.
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 40 billion (US$640 million). When the scam was
revealed, the Chairman of the Vijaya Bank committed suicide by jumping from the
office roof.[8] He knew that he would be accused if people came to know about his
involvement in issuing checks to Mehta. M J Pherwani of UTI was also linked to
Mehta.

6. Exposure
Exploiting several loopholes in the banking system, Mehta and his
associates siphoned off funds from inter-bank transactions and bought
shares heavily at a premium across many segments, triggering a rise in
the Sensex. When the scheme was exposed, banks started demanding
their money back, causing the collapse. He was later charged with 72
criminal offences, and more than 600 civil action suits were filed against
him.[6]
He was arrested and banished from the stock market with investigators
holding him responsible for causing a loss to various entities. Mehta and
his brothers were arrested by the CBI on 9 November 1992 for allegedly
misappropriating more than 2.8 million shares (2.8 million) of about 90
companies, including ACC and Hindalco, through forged share transfer
forms. The total value of the shares was placed at 2.5 billion
(US$40 million)

7. Break Down of Scam
 The scam was made possible by a complete breakdown of the
control system both within the commercial banks as well as the
control system of the RBI itself.
 We shall examine these control systems to understand how these
failed to function effectively and what lessons can be learnt to
prevent failure of control systems in the future.
 The internal control system of the commercial banks involves the
following features:
 Separation of Functions: The different aspects of securities
transactions of a bank, namely dealing, custody and
accounting are carried out by different persons.
 Counterparty Limits: The moment an RF deal is done on the
basis of a BR rather than actual securities, the lending bank
has to contend with the possibility that the BR received may
not be backed by any/adequate securities. In effect,
therefore, it may be making an unsecured loan, and it must
do the RF only if it is prepared to make an unsecured loan.
This requires assessing the creditworthiness of the borrower
and assigning him a "credit limit" up to which the bank is
prepared to lend. Technically, this is known as a
counterparty limit.

8. Where has all the money gone?
It is becoming increasingly clear that despite the intensive efforts by
several investigating agencies, it would be impossible to trace all the
money swindled from the banks. At this stage we can only conjecture
about where the money has gone and what part of the
misappropriated amount would be recovered. Based on the result of
investigations and reporting so far, the following appear to be the
possibilities:
 A large amount of the money was perhaps invested in
shares. However, since the share prices have dropped
steeply from the peak they reached towards end of March
1992, the important question is what are the shares worth
today? Till February 1992, the Bombay Sensitive Index was
below 2000; thereafter, it rose sharply to peak at 4500 by
end of March 1992. In the aftermath of the scam it fell to
about 2500 before recovering to around 3000 by August
1992. Going by newspaper reports, it appears likely that the
bulk of Harshad Mehta's purchases were made at low prices,
so that the average cost of his portfolio corresponds to an
index well below 2500 or perhaps even below 2000.
Therefore, Mehta's claim that he can clear all his dues if he
were allowed to do so cannot be dismissed without a
serious consideration. Whether these shares are in fact
traceable is another question.

9.  It is becoming increasingly clear that despite the intensive
efforts by several investigating agencies, it would be
impossible to trace all the money swindled from the banks.
At this stage we can only conjecture about where the money
has gone and what part of the misappropriated amount
would be recovered. Based on the result of investigations
and reporting so far, the following appear to be the
possibilities:
 A large amount of the money was perhaps invested in
shares. However, since the share prices have dropped
steeply from the peak they reached towards end of March
1992, the important question is what are the shares worth
today? Till February 1992, the Bombay Sensitive Index was
below 2000; thereafter, it rose sharply to peak at 4500 by
end of March 1992. In the aftermath of the scam it fell to
about 2500 before recovering to around 3000 by August
1992. Going by newspaper reports, it appears likely that the
bulk of Harshad Mehta's purchases were made at low prices,
so that the average cost of his portfolio corresponds to an
index well below 2500 or perhaps even below 2000.
Therefore, Mehta's claim that he can clear all his dues if he
were allowed to do so cannot be dismissed without a
serious consideration. Whether these shares are in fact
traceable is another question.

10. Impact of Scam
Impact of the Scam
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 government's 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.

11. NEWS Paper Article
Date: December 31, 2001

12. Date: November 3, 2003

13. Date : febuary 5, 2011

14. Date: November 9,2001

15. Date : October 23,2010

16. Reference
http://en.wikipedia.org/wiki/Harshad_Mehta#The_1992_security_scam
http://articles.timesofindia.indiatimes.com/2010-10-23/mumbai/28221697_1_harshad-mehtasecurities-scam-sbi-caps
http://articles.timesofindia.indiatimes.com/keyword/harshad-mehta
http://articles.timesofindia.indiatimes.com/2001-11-09/india-business/27260665_1_mehta-brothersharshad-mehta-securities-scam
http://www.scribd.com/doc/42325779/Harshad-Mehta-Case-Study
http://www.scribd.com/doc/42325779/Harshad-Mehta-Case-Study

17. Thank you