The 1992 Harshad Mehta Scam

Fig.1. Harshad Mehta

The Stock Market has seen hundreds of scams - both big and small. Some are insignificant, while others have changed the way the market works forever. The Harshad Mehta Stock Market scam is indubitably the latter. Harshad Mehta was a man - a Gujarati man - who disrupted the entire financial industry of India, causing a $1.3 Billion market manipulation. In short, at a time where banks were not allowed to invest in the stock market, he convinced them to send money to his personal account. He used this money to buy large quantities of stock, causing a huge - but fake - stock market financial boom. This article aims to unravel the mystery of the 1992 Stock Market Scam and display exactly what went down in the biggest financial scam of the Indian Stock Market.

A Little Bit About Harshad "Big Bull" Mehta

Harshad Mehta was born on July 29, 1954, in Paneli Moti, a small village in the Rajkot district of Gujarat, India. He moved to Mumbai with his family, where he completed his education and earned a degree in commerce. Mehta began his career with various odd jobs, including selling hosiery, cement, and insurance policies, before entering the stock market. His keen understanding of market dynamics and risk-taking attitude quickly propelled him into prominence. In the late 1980s, Harshad Mehta founded his consultancy firm, Growmore Research and Asset Management (popularly known as Growmore Investments). The firm quickly gained a reputation for its bold investment strategies and impressive returns. Under Mehta's leadership, Growmore Investments became a significant player in the Bombay Stock Exchange (BSE).

See - he wasn't all that bad. Harshad Mehta was a great stock broker who understood market dynamics well, and made successful returns for his clients - even before he indulged in conducting fraudulent market practices.

The Modus Operandi

The core of Mehta's fraudulent activities lay in his manipulation of the banking system. Mehta capitalized on the Ready Forward (RF) deal, a type of short-term loan where government securities were bought and sold among banks. Mehta convinced banks to issue fake Bank Receipts (BRs), essentially receipts for securities that banks agreed to hold in their portfolios. However, these BRs were issued without the actual securities backing them. Using these fake BRs, Mehta secured large sums of money from banks, which he then used to purchase shares in the stock market, driving up their prices. By creating artificial demand, he inflated stock prices, allowing him to sell off shares at significant profits. The repayment to the banks was made using these inflated stock prices, thus continuing the cycle.

The Unraveling

The scam began to unravel in April 1992 when journalist Sucheta Dalal exposed Mehta's fraudulent activities through her investigative reports. The revelation led to a collapse in the stock market, causing panic among investors and significant losses to many. The impact was immediate and widespread. Several banks were left with substantial non-performing assets due to the fake BRs, leading to a banking crisis. The stock market crash resulted in massive losses for investors, with the Sensex plummeting by 570 points in a single day, equivalent to a market value loss of ₹100,000 crore ($20 billion).

Legal and Regulatory Consequences

Following the scam's exposure, the government and regulatory bodies took swift action. Harshad Mehta, along with several bank officials and associates, was arrested and faced numerous legal battles. Mehta was charged with over 70 criminal offenses and more than 600 civil action suits. The Securities and Exchange Board of India (SEBI) introduced stringent regulations to improve transparency and accountability in the stock market. The Reserve Bank of India (RBI) also tightened controls over banking operations to prevent such frauds.

Long-term Impact

The Harshad Mehta scam had far-reaching consequences for the Indian financial sector. The scam led to the establishment of more robust regulatory mechanisms and frameworks to oversee stock market transactions and banking operations. The introduction of measures like online trading and dematerialization of shares aimed to reduce fraudulent activities. There was a renewed focus on investor protection, with SEBI playing a pivotal role in ensuring fair practices and preventing market manipulation. The scam heightened awareness about financial malpractices, leading to greater scrutiny of financial transactions by both regulators and the public.

Conclusion

Ultimately, The Harshad Mehta financial scam of 1992 was a watershed moment in Indian financial history. It not only exposed the vulnerabilities in the banking and stock market systems but also served as a catalyst for significant regulatory reforms. The legacy of the scam lies in its role in shaping a more transparent, accountable, and robust financial framework in India. As a cautionary tale, it underscores the importance of vigilance, integrity, and robust oversight in the financial sector to prevent future malfeasance.