Harshad Mehta securities scam
From Invertopedia, the encyclopedia of how things fail
Harshad Mehta was a Bombay stockbroker at the center of what the New York Times called the largest financial scandal in India's history[1]. Between April 1991 and May 1992, brokers diverted over Rs 3,500 crore from India's banks into the stock market[2], about $1 billion[1], much of it raised against fake bank receipts that lenders took to be backed by government securities[6]. Mehta's share was Rs 1,567 crore[2]. When it came out in 1992 the Sensex fell from 4,500 to about 2,500 and Mehta was charged with fraud, bribery, forgery and conspiracy[1][2]; in 1999 a special court convicted him in one of the cases and sentenced him to five years[3].
Contents
The bet
Indian banks were not allowed to invest directly in shares[6]. They lent to each other against government securities in ready forward deals, and the securities themselves rarely moved: the borrower handed over a bank receipt, a promise to deliver the securities at the end of the term, and lenders treated that paper as if the bonds stood behind it[6][7].
In the stock market, the bet was on Mehta. Retail investors followed what he bought[8], and between April 1991 and April 1992 the Sensex rose 274 percent, from 1,194 to 4,467, its highest annual return[8]. As long as prices kept rising, borrowed bank money could be put back with a profit and nobody had to look at the paper.
What happened
| Apr 1991 | The diversion of bank money to brokers begins, mostly through deals in government securities. It runs until May 1992.[2] |
|---|---|
| Apr 1991 to Apr 1992 | The Sensex rises 274 percent, from 1,194 to 4,467.[8] |
| Apr 1992 | The State Bank of India reports a shortfall in government securities, and the scam comes to light.[8] |
| Jun 5, 1992 | Mehta is taken to court in Bombay. He and nine other brokers and bankers are charged, and he goes to jail.[1][8][9] |
| Jun 1992 | More than $1 billion is missing from bank ledgers and some banks are technically insolvent. The Prime Minister orders a special court for the scandal.[1] |
| 1992 | The Sensex falls from 4,500 to about 2,500.[2] |
| Sep 1999 | A special court in Bombay convicts Mehta and three others in a case over Maruti Udyog funds and sentences them to five years' rigorous imprisonment and a Rs 25,000 fine each.[3][5] |
| Nov 9, 2001 | The CBI arrests Mehta along with Ashwin and Sudhir in a case of alleged misappropriation of Rs 250 crore from missing shares of 90 companies.[4] |
| Dec 31, 2001 | Mehta dies in judicial custody in Thane, with his appeal against the 1999 conviction still pending.[4][5] |
| Jan 14, 2003 | The Supreme Court upholds the conviction 2 to 1 and reduces the sentences to the time already served.[5] |
| Jul 2018 | A special court convicts five more people, including senior bank officials, in another case from the 1992 scam.[10] |
The kill shot
Banks lent against a receipt that only promised securities, let the broker handle the money between them, and never checked whether anything stood behind the paper.
Mehta got some banks to issue fake bank receipts and used them to raise money from other banks, which lent because they thought government securities backed the receipts[6]. Brokers had small banks, the Bank of Karad and the Metropolitan Cooperative Bank, issue such receipts as and when required[2]. Money that was supposed to buy securities went into Mehta's own account instead; in the case he was convicted for, Maruti Udyog funds held at Canara Bank were diverted to his account at ANZ Grindlays Bank[5][7].
The guard was down above the banks too. Santosh Nair, editor of CNBCTV18.com, writes that foreign banks and their brokers had been working the same loopholes before Mehta, and that the Reserve Bank of India knew and turned a blind eye[11].
Red flags ignored
- Paper in place of bonds. Lenders took a bank receipt, a promise to deliver later, as if the securities stood behind it.[6][7]
- Bank money in a broker's account. Money meant to buy securities went into Mehta's own account.[5][7]
- Tiny banks writing receipts on demand. The Bank of Karad and the Metropolitan Cooperative Bank issued receipts as and when brokers needed them.[2]
- A market up 274 percent in a year. The Sensex's best annual return ever came while one broker's buying set the mood.[8]
- A regulator that looked away. By one market editor's account, the RBI knew the system was being gamed and turned a blind eye.[11]
The cost
Barua and Varma's 1992 breakdown put the money at Rs 3,542 crore: Rs 1,567 crore to Mehta, Rs 1,870 crore to the Narottam and Hiten Dalal group and Rs 105 crore to Fairgrowth[2]. A Reserve Bank committee under deputy governor R. Janakiraman estimated the scam at Rs 4,024 crore[6]. By June 1992 more than $1 billion was missing from bank ledgers and some banks were technically insolvent[1].
The Sensex fell from 4,500 to about 2,500, a paper loss of Rs 1 lakh crore[2], and millions of investors lost money[9].
The inversion
Never lend against a promise of collateral you have not seen, never let the middleman hold the money between two banks, and give every counterparty a limit, so a small bank cannot write a receipt for more than it could ever own.
What survived
Mehta was released after more than three months in custody in 1992[12][13]. In 1997 he tried a comeback as a stock tipster with a website and a newspaper column, and a Securities and Exchange Board of India inquiry found he had set up a network of investment companies to front his trading[12]. When he died he was appealing a life ban on trading and left many cases unsettled[12].
The trials outlived him. The Supreme Court ruled on his appeal in 2003, after his death[5], and a special court was still convicting bank officials over the scam in 2018[10].
References
- ^ “Huge Financial Scandal Shakes Indian Politics”. The New York Times, June 9, 1992. The $1 billion scale, largest in India's history, the charges against Mehta and nine others, the special court, missing money and technically insolvent banks.
- ^ “Securities Scam: Genesis, Mechanics and Impact”. Samir K. Barua and Jayanth R. Varma, IIM Ahmedabad working paper, September 1992 (Internet Archive copy). The period and size of the diversion, the split by beneficiary (Mehta Rs 1,567 crore), the Bank of Karad and Metropolitan Cooperative Bank receipts, and the Sensex fall from 4,500 to 2,500.
- ^ “Harshad Mehta sentenced to five years' RI”. UNI via Rediff, September 28, 1999. The special court's conviction of Mehta and three others in the Maruti Udyog case, five years' rigorous imprisonment and the Rs 25,000 fine.
- ^ “Harshad Mehta cremated”. PTI via The Economic Times, December 31, 2001 (Internet Archive copy). Death in judicial custody at Thane, and the November 9, 2001 CBI arrest in the missing-shares case.
- ^ “SC upholds Harshad Mehta's conviction”. The Times of India, January 14, 2003 (Internet Archive copy). The 2 to 1 Supreme Court ruling, Mehta's death while his appeal was pending, the sentences cut to time served, and the Maruti Udyog charge.
- ^ “'Scapegoat' or mastermind of 1992 scam? Harshad Mehta's fall from grace still haunts family”. ThePrint, July 29, 2022. Fake bank receipts used to borrow from other banks, lenders believing government securities backed them, the bar on banks buying shares, the Janakiraman committee's Rs 4,024 crore estimate.
- ^ “1992 Indian stock market scam”. Wikipedia. How ready forward deals and bank receipts worked, and bank money routed into Mehta's account (cross-check alongside ThePrint and the IIM Ahmedabad paper).
- ^ “Economic Milestone: Stock Market Scam (1992)”. Forbes India, August 20, 2014 (Internet Archive copy). Retail investors following Mehta, the Sensex's 274 percent rise from 1,194 to 4,467, the SBI shortfall, and Mehta taken to court on June 5, 1992.
- ^ “Securities scandal: Harshad Mehta being put behind bars, millions lose their fortune”. India Today, June 30, 1992. Mehta jailed in June 1992, and millions of investors losing money.
- ^ “1992 securities scam: Senior bank officials among 5 sentenced”. PTI via The Times of India, July 7, 2018. Five people, including senior bank officials, convicted in a 1992 scam case in 2018.
- ^ “Scam 1992: Was Harshad Mehta the mastermind or fall guy of securities scam? A bit of both”. CNBC-TV18 (Santosh Nair), October 25, 2020. The editor's view that foreign banks and brokers worked the same loopholes earlier and that the RBI turned a blind eye.
- ^ “Harshad Mehta (obituary)”. The Guardian, January 14, 2002. Release after 107 days in custody in 1992, the 1997 comeback, the SEBI finding, the life-ban appeal and unsettled cases.
- ^ “Scam-tainted stockbroker Harshad Mehta passes away”. India Today, January 14, 2002. A 111-day incarceration in 1992 (the Guardian says 107 days; the entry says more than three months).