NATIONAL LAW UNIVERSITY ODISHA

NATIONAL LAW UNIVERSITY ODISHA – SEMESTER IX || BATCH 2018 - 23

PROJECT || WHITE COLLAR CRIMES

TOPIC- A CASE STUDY ON HARSHAD MEHTA SECURITIES FRAUD: THE CRIME AND THE CONTINUING
LOOPHOLES IN THE INDIAN BANKING SECTOR

SUBMITTED TO:

Dr. ANUP KUMAR PATTNAIK

(Professor of Law, National Law University Odisha

SUBMITTED BY:

Manas Pratap Singh – 2018/B.A.LL.B/054

Shrestha Roy – 2018/B.A.LL.B/100

Troeeta Bhuniya – 2018/B.A.LL.B/111

 TABLE OF CONTENTS

INTRODUCTION..............................................................................................4

THE HARSHAD MEHTA SCAM....................................................................7

AFTERMATH..................................................................................................11

ACTIONS THAT SHOULD HAVE BEEN TAKEN BY THE

GOVERNMENT..............................................................................................11

LESSON LEARNED........................................................................................12

ADOPTION OF REFORMS...........................................................................13

CONCLUSION.................................................................................................14
 INTRODUCTION

In many ways, the securities scam—irregularities in banks' and financial institutions'

securities transactions—that surfaced in the second quarter of 1992 are unparalleled. The
number of people and institutions involved was astounding, as was their involvement.
Among others, it includes foreign banks, financial, and other public and private sector
corporations, the major stock exchanges, a small group of brokers, and people holding
influential positions.

Corruption is viewed as a key development issue. Corruption has been one of the persistent
“

problems affecting India since from independence. Economic reforms of 1990 further
broadened the base of corruption. Number of committees and commissions highlighted on
the issue, but no concrete measures were taken up by any government to tackle the problem
of corruption. Over a period of time corruption spread its roots deep in the society. So much
so that, there emerged a general belief that, no policy or law will be able to root out
corruption completely.1 The detection of the massive fraud in dealings in securities of banks
and financial institutions raises matters of grave im- portance for the country's financial
system. The public observations of members of the Joint Parliamentary Committee (JPC)
and the critical comments in the media have emphasized the need to unravel individual
culpability in the whole episode, which” is no doubt important.2

1. Stock Market & Fraud

The stock market is described as the location where business owners generate funds by
selling purchasers a tiny portion of their ownership. It is a location where shares are bought
and sold. However, it turns into a stock market scam when brokers, dealers, insiders, and
traders deceive people into purchasing shares at an inflated price. The targets of the crime
are investors. Investors are consistently seduced by fraudsters, whether it is through

1
Alaknanda Shringare, 'Corruption: The Need for Civil Society Engagement' (2013) 74 (3) IJPS
<https://www.jstor.org/stable/24701056> accessed 16 September 2022.
2
Economic and Political Weekly, 'Securities Scam: The Systemic Origins' (1992) 27 (36) EPW
<https://www.jstor.org/stable/4398839> accessed 16 September 2022.
guaranteed income schemes or advance fee for high return scandals. The smell test must be
passed by opportunities that seem too good to be true.3

A security scam4 has the following features:

a. manipulation in share prices.

b. monopoly in dealing with a huge number of shares of a company
c. money laundering – borrowing money to trade in securities but using the funds for
unconnected purposes.

2. Types of Stock Market Frauds

 Market Manipulation: Controlling or artificially influencing the price of securities or

purposeful interfering with the free dynamics of supply and demand in order to
deceive or defraud investors. It may be created to raise or lower a stock's price.5
 Insider trading - Buying or selling a securities while violating a fiduciary
responsibility or another relationship of trust and confidence on the basis of
significant, private knowledge about the security is referred to as insider trading.
Additionally, "tipping" such information, trading in securities by the person "tipped,"
and dealing in securities by individuals who improperly get such information are all
examples of insider trading crimes.6
 Price/ Volume Rigging - Price rigging is when parties agree to fix or artificially
inflate prices in order to increase profits at the expense of consumers. It may happen
in any business and is often forbidden. Manufacturers and sellers may try to establish
pricing floors, agree on a standard minimum price or book price, restrict markups or
discounts, agree to apply or restrict comparable surcharges, or divide up markets or
clientele to reduce competition there.7

3
CA Mayur Joshi, 'Definition and Classification of Stock Market Frauds' (Indiaforensic, 13 October 2021)
<Definition and Classification of Stock Market Frauds (indiaforensic.com)> accessed 16 September 2022.
4
Scott K.E., 'Insider Trading. In: Newman P. (eds) The New Palgrave Dictionary of Economics and the Law'
(Palgrave Macmillan, London, 2002) <https://doi.org/10.1007/978-1-349-74173-1_186> accessed 6 October
2022.
5
Tom Swiers, 'Market Manipulation' (Office of International Affairs, U.S. Securities and Exchange
Commission) <Quebec (sec.gov)> accessed 6 October 2022.
6
U.S. Securities and Exchange Commission, 'Insider Trading' (SEC) <Insider Trading | Investor.gov> accessed
6 October 2022.
7
Will Kenton, 'Crime Fraud: Price Rigging' (Investopedia, 21 July 2021) <Price Rigging Definition
(investopedia.com)> accessed 6 October 2022.
  Synchronized Trade - A synchronised trade is a type of transaction in which the
buyer and seller carry out the deal at nearly the same time and for nearly the same
quantity. It's crucial to remember that in such a sale, sellers never relinquish control or
ownership of the asset they trade in.8
 Others - Similar to LTCG Fraud and Reversal Trade in the F&O Segment, where like
all others, the fraud occurs on the stock market, causing price manipulation and
frequently associated with pump and dump scam.

3. Indian Laws on Securities Fraud Regulations

Since a few years ago, the Indian government has actively worked to change its reputation for
recognising financial frauds and corruption only after they had already occurred. To this end,
laws have been changed, regulations have been implemented, and there are now strict
disclosure requirements for various regulators. The Board of Directors and Key Managerial
Persons already have severe disclosure requirements and responsibilities 9 under the
Companies Act of 2013 and the Listing Regulations, which also place a strong focus on the
timing of disclosure.

The 2018 revision to the venerable Prevention of Corruption Act, 1988 ("Act") was a positive
move. The amendment expanded its scope to include punishing commercial organisations for
the actions of their directors, managers, and other officers working in concert as well as the
bribe-giver.10

The Indian government announced new auditor standards, known as the Companies
(Auditor's Report) Order, 2020 (or "CARO 2020/Order"), earlier this year in an effort to curb
corporate frauds and scams. These standards call for additional disclosures in reports.
Companies must disclose, among other things, whether any fraud committed by the company
or against the company during the year was noticed or reported, and if so, what kind of fraud
it was and how much it cost. Additionally, auditors must take into account any whistle-
blower complaints that may have been made during the year. This, among other things, opens
the door for auditors to exercise greater vigilance and disclosure, particularly with regard to
the company's financial management.11
8
Securities and Exchange Board of India (SEBI) v. Pursarth Trading Company Pvt. Ltd. MANU/SB/0084/2007.
9
The Companies Act 2013.
10
The Prevention of Corruption (Amendment) Act 2018.
11
Payel Chatterjee, Sahil Kanuga & Vyapak Desai, 'Indian Regulators Tighten the Noose for Early Detection
and Disclosure of Financial Frauds' (The National Law Review, 28 October 2020) <Securities and Exchange
The Securities and Exchange Board of India has issued the SEBI (Listing Obligations and
“

Disclosure Requirements) (Third Amendment) Regulations, 2020, w.e.f. 08.10.2020

whereby, inter alia, in case of initiation of forensic audit (by whatever name called) a listed
company is required to make following disclosures to the stock exchange:

 Initiation of a forensic audit along-with name of entity initiating the audit and
reasons for the same, if available; and
 Final forensic audit report (other than for forensic audit initiated by regulatory /
enforcement agencies) on receipt by the listed entity along with comments of the
management, if any

This has been included under events which shall be disclosed without any application of the
guidelines” for materiality.12

Board of India SEBI Regulations (natlawreview.com)> accessed 16 October 2021.

12
SEBI (Listing Obligations and Disclosure Requirements) (Third Amendment) Regulations 2020.
 THE HARSHAD MEHTA SCAM

The phrase "securities scam" refers to a sequence of transactions between April 1991 and
May 1992 in which more than Rs. 3500 crores were diverted from the banking system to
various stockbrokers. These transactions mostly included government securities. For several
months, the con has consistently been on newspaper top pages. The majority of readers had
trouble understanding the fraud despite the widespread media coverage, especially when they
encountered obscure terminology and acronyms like ready forward, double ready forward,
SGL, PDO, BR, PMS, etc. But any serious consideration of policy solutions to enhance the
efficiency of the financial system must start with a comprehension of the fraud.

1. About Harshad Mehta

Harshad Mehta altered how people view the stock market and how brokers do business.
Mehta was involved in the securities fraud in 1992, which resulted in significant stock market
changes and revealed weaknesses in the nation's banking system.13

He travelled from the tiny town of Raipur to Mumbai in search of a better life after being
born on July 29 into a Gujarati Jain family of low means. In Mumbai, he got his first work as
a dispatch clerk for the New India Assurance. Working with stockbrokers, he soon succeeded
in obtaining a brokers' card. He soon launched his own business, Grow More Research and
Asset Management Company Ltd., and rose to fame in the financial industry as a dream
salesman. This individual is referred described as "The Big Bull" of the Indian stock
exchange. Following Big Bull suggestions, stock demand used to increase rapidly. 14 He was
also called the “Amitabh Bachchan of the Indian Stock Market – a tag that he earned due to
the flamboyant lifestyle after becoming a celebrity – status stockbroker.

13
ET Online, 'The story of Harshad Mehta and five ways it changed Dalal Street' (The Economic Times, 21
October 2020) <The story of Harshad Mehta and five ways it changed Dalal Street - Banking loopholes | The
Economic Times (indiatimes.com)> accessed 6 October 2022.
14
ibid.
The "Replacement Price Theory" was his idea. The notion essentially contends that the worth
of existing businesses should be determined by the sum of money needed to start a similar
business. He was accused of planning the BSE stock exchange's expansion in 1992. The
Times of India columnist Sucheta Dalal highlighted Harshad Mehta's questionable practises
on April 23, 1992. Later, he was accused of 72 crimes, and more than 600 civil lawsuits were
brought against him. He was the subject of several ongoing legal proceedings when he passed
away in 2002 in a Thane prison from a major heart attack.15

2. Overview of the Scam

Banks lend money to one another, and one such deal was the ready-forward arrangement,
which is essentially a bank receipt secured by some collateral. These bank-to-bank
transactions were used by Mehta's company as a broker. He allegedly delayed a week (or
more) to exchange a bank receipt between two banks, and in the meanwhile, he gave the
second bank a week to locate a buyer. He was able to constantly have collateralized backed
assets from different banks that were virtually "in transit" because to the circulation that took
place across many institutions. They served as the means of payment for rash stock market
investments. The "scam" was really just a case of bad regulation.16

Mehta rose to prominence in the Indian stock market by 1990. He began making substantial
“

share purchases. He was primarily interested in the shares of Associated Cement Firm
(ACC), the largest cement producer in India, and it is known that the con artist increased the
price of the cement company from 200 to 9000 (approximately) on the stock market, a
growth of 4400%. Mehta's use of the replacement cost theory to justify the high-level bidding
is said to have been later” disclosed.17

3. The Modus Operandi

15
Jeetendraa Singh, Manoj Panjwani, Nitesh Khanna, Prerna Bhadani, & Sangeev Jha, 'A Project Report on
India’s Securities Scam by Harshad Mehta' (2012) JIM.
16
Aishwarya, PT Sairam, Ravi Teja & Zhou, 'A Case study on Harshad Mehta' (Slidehsare, 14 January 2017)
<A Case study on Harshad Mehta (slideshare.net)> accessed 16 October 2021.
17
Pavan Kumar Vijay, '‘Frauds’ in Indian Securities Market' (Corporate Professionals) <PowerPoint
Presentation (corporateprofessionals.com)> accessed 6 October 2022.
This fraud falls under the category of capital market fraud since it involves misrepresenting
the truth in order to make substantial gains. This fraud included two distinct components:

a. Diversion of the Funds

Mehta and his friends were charged in 1992 for influencing the growth of the Bombay Stock
Exchange (BSE). They syphoned out money from inter-bank transactions by taking
advantage of the numerous banking system flaws. They then purchased enormous quantities
of shares at a premium across several business verticals, which caused the Sensex to climb
sharply. This, however, was not going to last. When Mehta's methods were made public,
banks began to seek their money back, which caused the Sensex to almost rapidly decline as
it had climbed.18

b. Use of Ready Forward (RF) to maintain Statutory Liquid Ratio (SLR)

The Times of India's experienced journalist Sucheta Dalal published an article on April 23,
1992, exposing Mehta's illegal stock market manipulation techniques. "The ready forward
(RF) agreement was a key component of how the fraud was carried out," Dalal said in his
piece. The RF is essentially a secured, quick loan between banks, often for a period of 15
days. Simply put, a pawnbroker loans against jewellery, just as a bank lends against
government securities. At the end of the loan period, the borrowing bank actually sells the
securities to the lending bank and buys them back, often at a little higher price. A broker
often brings together two banks in a ready-forward arrangement for which he receives a
commission. Even if the broker doesn't deal with the money or the securities, this wasn't the
case in the Mehta scam's precursor. Mehta and his accomplices successfully channelled
money via banks using this RF transaction.19

4. Outcome of the Scam

18
Supreena Narayanan, 'Financial Market Regulation-Security Scams In India with historical evidence and the
role of corporate governance' (2007) 4438 MPRA <https://mpra.ub.uni-muenchen.de/4438/> accessed 6 October
2022.
19
Sucheta Dalal, 'Harshad Mehta's Conviction: How Not to Handle Financial Crimes' (1999) 34 (40) EPW
<https://www.jstor.org/stable/4408473> accessed 6 October 2022.
Mehta persisted in his manipulative strategies, resulting in a sharp increase in stock prices
and a positive market trajectory. However, numerous institutions discovered they were
holding BRs with absolutely no value once the scheme was exposed. By that point, Mehta
had defrauded the banks of an incredible Rs 4,000 crore. The scandal received harsh
condemnation in the Indian Parliament, which ultimately resulted in Mehta's incarceration.
The Vijaya Bank Chairman passed away as a result of the scam's disclosure; he is said to
have committed himself as a result. He anticipated the public response of charges he would
have to endure since he had written cheques to Mehta. 20The accused had exchanged a
significant volume of shares during the previous year since they were active stock market
brokers. All of these shares were polluted, rendered useless, and unable to be traded. A few
years later, Mehta briefly returned to the public eye as an authority on the stock market and
began offering investing advice on his website and in a weekly newspaper column. He
exclusively suggested the shares of the few firms whose owners he dealt with. Mehta had
only been found guilty in one of the 27 charges brought against him before he passed away in
2002. Mehta's advance tax payment of Rs 28 crore for the fiscal year 1991–1992 caught the
notice of the taxman. The opulent way of life he led was another eye-catcher.21

When journalist Sucheta Dalal published a piece on the fraud in the Times of India in 1992,
the scandal came to light. Following Mehta's arrest, a probe was launched. Only four of the
27 criminal proceedings brought against him had resulted in a conviction by November 1992.
After the hoax was exposed, several changes were implemented to ensure that the market
would never again be subject to manipulation. Following this fraud, the National Stock
Exchange of India (NSE) was established. Thanks to the Harshad Mehta Scam, the Securities
and Exchange Board of India (SEBI), which was established in 1988 as a non-statutory body
to regulate the stock markets, received encouragement to speed up the process of stock
protection and regulation and subsequently become a much more mature authority than it was
when it was established. The SEBI Act, 1992 was approved by the Indian government in
1992, establishing it as an independent agency with statutory authority and establishing it as
the country's capital markets regulator. Concerns about the Indian stock markets' openness
were brought on by the Harshad Mehta Scam.

20
R.B. Jain, 'The Craft of Political Graft in India: An Analysis of Major Scams' (1994) 55 (4) IJPS
<https://www.jstor.org/stable/41855706> accessed 6 October 2022.
21
ibid.
 AFTERMATH

Looking into the entire instance of the scam: it can be rightly said that the brokers were not
the only ones responsible here – especially since the same account can be seen reflecting onto
the Government, the RBI, and the commercial banks. After all, the fact remains that end of
the day the brokers had been encouraged by the banks themselves to put their funds into the
stock market in the first place instead of the banking system. From another perspective, even
though the RBI knew of the Banks overstepping their boundaries and their duties as was seen
being done by them given the fact that they were constantly demarcating their arena of
operations. RBI can be said to have failed in their liability to reign in the banks, as they did
not take any sort of action against the antics of the commercial banks.

Hence, analysing the entirety of the picture together what we see is that the looting that had
been done in this case was with the full knowledge and under the nose of the very authorities
that had been given the responsibility to guard this type of situation. It will not be bold to
come to the opinion that such an incident could have been easily avoided if any of the actors
i.e., be it the commercial banks, the RBI or even the Government had done their duties
correctly and had not invigorated the brokers into investing in the stock market instead.22

ACTIONS THAT SHOULD HAVE BEEN TAKEN BY THE GOVERNMENT

Looking into the various analytics of the whole situation surrounding the scam and the
different facets at play which can be seen moulding the whole scenario that government
reacted mainly in four ways:

1. Punitive measure: Task was given to the Central Bureau of Investigation to identify
the individuals that were involved and punish them likewise in accordance to their
guilt. The Joint Parliamentary Committee also helped out in this determination along
with the setting up of a special court which was done mainly to conduct speedy trials.

22
Economic and Political Weekly, 'Unlearnt Lessons' (2002) 37 (20) EPW
<https://www.jstor.org/stable/4412113 > accessed 8 October 2022.
 2. Dealing with the Scam itself: In order to curb the effects of the scam the government
not only set up a special court but also fixated on the release of several draconian
provisions. The ordinance so passed in the Section (3) and (4) clearly mentioned all
the properties of the accused voiding any sort of transaction that had been routed
through them after 1991, 31st March.

3. Recovery: The provisions as presented by the Ordinance were attempts of recovering

the money especially with the consequent creation of the idea of “tainted” shares.

4. Reformation: Looking into the reforming of the system after the incident, measures
taken by the government were seen to be in the form of banning the RF deals and the
slow pace evolution of liberalization.23

LESSON LEARNED

When looking back into the whole scenario – where it was important to get back the money
so swindled from the banks the methods employed to achieve the same can be said to be quite
unfair by nature. While legislatures have, consistently, guaranteed exceptional abilities to
recuperate contribution like land income and duties, a similar rule can't be stretched out to
recuperation of sums which the public authority possessed associations (or so far as that is
concerned, the unfamiliar banks) have lost by their own carelessness and complicity. There
can be no legitimization for such measures as the "tainted" shares regulation which irritate
veritable innocent financial backers independent of the extent of the loss so incurred. The
most valuable response would be in the field of changes of the financial system.

(i) Unfair and Over Regulation of the Markets:

The roots of the deception, in our opinion, are mostly in excessive regulation of our markets.
The money market laws were such that perfectly acceptable and necessary transactions were
unable to be carried out overtly, but had to be concealed and hidden. The involvement of
brokers and some banks as market makers wasn't really acknowledged, therefore they could
only fulfil those vital and beneficial services through trickery. To enable quick financial

23
Jayanth R. Varma & Samir K. Barua, 'Securities Scam: Genesis, Mechanics and Impact' (1993) 18 (1) Vikalpa
<http://www.iimahd.ernet.in/vikalpa> accessed 8 October 2022.
transactions, the payment and clearance systems were so old and onerous that completely
indefensible alternatives had to be used. The ultimate upshot of all of this was a complete
absence of accountability in money market transactions.

Perturbations of all sorts were just so widespread that even extremely unusual activities did
not raise concerns. The circumstances were optimal for such a scam to start and flourish to
dangerous dimensions. We might even claim that parts of the bank's controllers failed since
they were purposefully permitted to deteriorate by both commercial banks and the RBI in
order to speed up daily operations in contravention of the RBI standards.24

(ii) Insulations of closely Related Markets and its counter-productivity:

The con job also teaches us that artificially isolating closely related markets from one another
is damaging in the long haul. Money, like liquid, pursues the optimum rates of return without
making appropriate modifications for volatility and liquidity. Yet after a decade of gradual
financial sector modernization, regulatory barriers continue between both the money market
and the stock market, in between market for corporate bonds and the market for government
securities, as well as between traditional and informal money markets. Unification of such
sectors, along with the associated distribution of outcomes in such markets, must be given
precedence in the roadmap for financial reforms. This convergence would enable a consistent
yield curve to evolve across all capital markets.25

ADOPTION OF REFORMS

SEBI has emerged as a key game changer inside the nation's market regulation and defence
over time. The Mehta scandal exposed a large area that SEBI was now compelled to cover
and investigate. Throughout time, a succession of legislation was enacted that gave the
regulator the authority to control depositories, FIIs, venture capital funds, and credit-rating
organisations. To sustain investor sentiment, SEBI would mandate declarations by
corporations issuing securities. These regulations broadened SEBI's authority and provided it
complete jurisdiction to examine and assess white-collar crime in the Stock Exchange. Its
24
C. P. Chandrasekhar and Parthapratim Pal, 'Financial Liberalisation in India: An Assessment of Its Nature and
Outcomes' (2006) 41 (11) <https://www.jstor.org/stable/4417962> accessed 8 October 2022.
25
Jitendra Narayan, 'Corruption in Administration in Ancient India' (2005) 66 (3) IJPS
<https://www.jstor.org/stable/41856149> accessed 8 October 2022.
enforcement agency may very well call individuals, compel the presentation of records of
transactions, and undertake investigations, audits, and examinations of MFs, stock exchanges,
as well as other intermediaries. SEBI was also granted exemption from civil litigation. The
attitude was one of empowerment for the operator. This did, in fact, play a part in its genesis.
SEBI was given the authority to impose severe financial harm on any scammer.
 CONCLUSION

Whilst country's system of corporate governance is comparable to that of various

other mature markets, it needs to be applied in both text and substance. The fact that white
collar crime persists, and appears to be expanding, implies that the projected costs do not
balance the anticipated rewards of cheating. More severe sanctions are required. The security
scams and financial scandals covered here included large sums of money being manipulated.
The so-called "traders" or "investors" had no actual goal. The offenders had such a thorough
understanding of how the system functioned that they were able to influence it. The
emergence and frequent occurrence of these kind of security frauds and financial scandals
may obviously be ascribed to a breakdown of corporate governance in finance and financial
supervision oversight at a certain point in time.

Security frauds in India are not to be forgotten. The numerous examples of corporate
wrongdoing have indeed changed the spotlight to conformance with substance rather than
form, highlighting the significance of cognitive credibility. condor and transparency. This
happens because every firm's financial and nonfinancial statements can only be as
trustworthy and truthful as the individuals driving them. According to this notion, only
entrepreneurs whose firms are properly run ought to be allowed to serve as a part
of committees. It thus involves advisory councils for the Prime Minister and Finance
Minister, organisations established by the Confederation of Indian Industry ("CII"), the
Securities and Exchange Board of India ("SEBI"), the Department of Company Affairs,
ministries, as well as the boards of large financial institutions and banks.

For every marketplace to thrive and maintain appropriate expansion over time, it must be free
of all frauds, criminal activities, unjust and deceptive tactics. The same is true for the
securities market. The Securities and Exchange Board of India (SEBI) has undertaken every
measure possible to ensure protracted development and protection of the people who engage
in the securities market. Because of the demographic and the enormous number of investors
who enter the market in India, there is a higher potential for forgery to occur. Additionally, in
the modern technology era, India falls behind other industrialised countries in cybersecurity.
Although most securities are now managed via digital sites, software, and so on, SEBI should
also implement cybersecurity regulations and a cyber security wing to safeguard the
securities market from every potential cyber hacking, ultimately safeguarding and directing
the Indian securities market towards a path of progress and development.