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, with over one billion USD
defrauded. Techniques used by Mehta involved having corrupt officials signing fake
cheques, misusing market loopholes, and telling lies 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 INR in now useless debt.

Overview
The scam was the biggest money market scam ever committed in India, amounting to
approximately Rs. 5000 crores. The main perpetrator of the scam was stock and money
market broker Harshad Mehta. It was a systematic stock fraud using bank receipts and
stamp paper which caused the Indian stock market to crash after it was saved by him from
bankruptcy of India. 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 made the entire securities system collapse. He committed a fraud
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
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 health budget 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 sell
the stocks that he owned in these companies. The impact of the scam had many
consequences, which included the loss of money to lakhs of families and the immediate
crash of the stock market. The index fell from 4500 to 2500 representing a loss of Rs.1000
billion in market capitalisation. The 1992 scam raised many questions involving bank officials
responsible for being in collusion with Mehta. An interview with Montek Singh Ahluwalia
(Secretary, economic affairs at the Ministry of Finance) revealed that many top bank officials
were involved.

Stamp paper scam

In the early 90'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 (threshold) 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 (such as that of ACC, Sterlite Industries, and Videocon)
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. this is correct.

Bank receipt scam

Another major instrument was the bank receipt (BR). 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 liaison 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 very 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 Janaki Raman Committee restructured the entire Bank Receipts
system after the 1992 scam.

Mehta used forged BRs 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 into 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
(equivalent to ₹250 billion or US$3.5 billion in 2019). He knew that he would be accused if
people came to know about his involvement in issuing cheques to Mehta. 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. Venkatraman 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.
Name of Bank ₹ in crores

National Housing Bank 1199.39

State Bank of Saurashtra 175.04

SBI Capital Markets Ltd 121.23

Standard Chartered Bank 300.00

Total 1795.66

Exposure, trial and conviction

Exploiting several loopholes in the banking system, Mehta and his associates siphoned off
funds from inter-bank transactions and bought shares at a premium across many segments,
triggering a rise in the BSE 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.

He was arrested and banished from the stock market with investors holding him responsible
for causing losses 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 of about 90
companies through forged share transfer forms. The total value of the share’s
misappropriation was placed at ₹250 crore (equivalent to ₹15 billion or US$220 million in
2019).

Mehta made a brief comeback as a stock market guru, giving tips on his own website as well
as a weekly newspaper column. However, in September 1999, Bombay High Court convicted
and sentenced him to five years rigorous imprisonment and a fine of ₹25,000 (US$350). On
14 January 2003, The Supreme Court of India confirmed High Court's judgement in a 2–1
decision. While Justice B.N. Agrawal and Justice Arijit Pasayat upheld his conviction, Justice
M.B. Shah voted to acquit him.

Allegations of payment of bribe to India's prime minister

Mehta raised a furor on announcing that he had paid ₹10 million to the then Congress
President and Prime Minister, P.V. Narasimha Rao, as a donation to the party, for getting
him off the scandal case.

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 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 Grind lays 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 Fair growth Services Limited (FFSL) and
Andhra Bank Financial Services Ltd (ABFSL). 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 (USD $740 million). 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 (now,
Mumbai).

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 reconciliated Bank Receipts and Subsidiary General Ledgers to prevent
fraudulent transactions. On the advisory of the Janaki Raman Committee, a committee was
established to oversee the Securities and Exchange Board of India. The primary
recommendation of the committee was limit ready forward and double ready forward deals
to government securities only. All banks were made custodians 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).