THE 1992 INDIAN STOCK MARKET SCAM

"I would probably find a place in The Guinness Book of World Records, going by the number of criminal and civil cases against me”

~Harshad Mehta

The Coronavirus Pandemic has impacted our lives tremendously. It’s effects have led to a decrease in income, a rise in prices and several lockdowns have caused market crashes. Market crashes are the result of various unfavourable events or black swan events. It is very rare for only one factor, or in this case- a mere human, to lead the market down by a few thousand points. One such scam, in 1992, shook the entire Indian stock market, it is known as The 1992 Harshad Mehta Scam or India’s Biggest scam.

It’s astonishing to know that a man, who arrived in Mumbai with only 40 Rupees in his pocket, held the power to run a scam worth over Rs.5,000 crores.

To understand the scam, I am going to rewind the clock to the early years of liberalization in the Indian economy. The markets were opening up to the private sectors, the stock market was thriving and there was a sudden increase in borrowings. The Government of India, to cover its expenses, issued securities, like bonds. They were sold to the public and people bought them because of the interest they got from it. The Government had also made it mandatory for all banks to maintain a certain amount of bonds and invest in them. The minimum threshold that the banks had to maintain as bonds in 1990 was set at 38.5%. The rise in the net demand of banks prompted the banks to borrow an amount of money from another bank by giving it bonds as security. The borrowed money was later repaid with interest, to get the bonds back.

Every time a bank sells or buys a bond it has to be registered in the RBI and without computers back then, this process would take days. Which is why instead of transferring the bonds, banks transferred Bank Receipts (BR). The BRs were short-term IOUs (I Owe You). In the 90s, there was a 14-day settlement cycle and at the end of this, the borrowing bank had to buy the BR back at a higher price from the lending bank, this included the interest paid. But what if the bank didn’t have money to repay at the end of a settlement cycle? In such cases the settlement cycle would be extended and the borrowing bank would pay a badla rate to the lending bank.

Now, assume that A has bought stocks worth 1 lakh from B, but he doesn’t pay back by the end of the settlement cycle because he sees an upward trend in the market. A decides to further hold the shares as there is a good possibility that the prices might rise. He then pays B a badla rate to extend the settlement period by 14 days. If the badla rate is Rs.1000 and A is able to make Rs.1,10,000 from the market, he will make a profit of Rs.9000. This was known as the Carry Forward Deal.

Harshad Mehta took advantage of these loopholes and exploited it. He acted as an intermediary between two banks and brokered RF deals for them. He would approach Bank A (which wanted to sell its bonds) and take bonds from it and later approach Bank B (which wanted to buy bonds) and convince them to have the cheques drawn in his name. He carried forward these deals and used the money to pump up the stock market thereby manipulating it. When the banks demanded that their money or RF must be paid back, Harshad would persuade a third bank and this recursively continued. Both the banks did not know who they were trading with because Harshad intermediated between them. Even though the banks were aware of Harshad Mehta’s game, they chose to look away as he transferred a percentage of his profit to the banks.

That was not it, the real money game started when Harsad Mehta realized that Ready Forward Deals(RFD) would come to pass only by Bank Receipts(BR). Along with Bank of Karad and Bombay Mercantile Co-operative Bank, he began to forge bank receipts which could be exchanged for a ton of money!

The more money he collected, the more jolts he induced in the stock market. The stock market was soaring as he introduced a bullish trend in the markets, which is when he got the name The Big Bull.

Back in the 90s, there were various counters for different stocks and people had to be present at the trading pit to trade. It is said that when Harshad Mehta entered the pit, everyone would eagerly look at him walk towards a stock. When he bought it, the price would go up 60-70% in a single day. The prices of any stock he invested in would hike. He raised the price of ACC stocks from Rs.200 to Rs.9000 per share in just 2 months!

This bull run came to an end on the 23rd of April 1992 when Sucheta Dalal, a journalist, wrote an article in The Times of India exposing The Harshad Mehta Scam. The scam led to a loss of about 1,00,000 crores Rupees to the investors and banks? They had lost a great deal of money. In fact, many even committed suicide as this bitter news broke out. All this resulted in Sensex plummeting from 4500 to 2500 points. Harshad Mehta was charged with 72 criminal offenses and more than 600 civil cases, most of which are still pending today.

When he was bailed out in just 3 months, he was received as a hero back into the share market community, where he then started giving trading tips to young investors. In September 1999, the Bombay high court sentenced him to 5 years of imprisonment. He died of cardiac arrest in Thane Prison at the age of 48.

The markets had crashed by 72% and this led to a bearish phase that lasted for two years. To avoid such scandals in the future, corporate governance codes were changed, SEBI was given the power to monitor the stock market, Ready Forward Deals and Bank Receipts were also banned and it was made mandatory for every bank to have a separate portfolio auditor. And just when SEBI thought they had closed all loopholes, another scam hit the front pages in 2001. This time it was carried out by Ketan Parekh, the former mentee of Harshad Mehta!