Harshad Mehta Scam: Analysis of India’s Infamous Financial Fraud

Garima Harsh 22 Jun 2023 30,732 Views 0 comment Print Finance | Articles

1. Introduction to Harshad Mehta Scam

The Harshad Mehta Scam of 1992 is one of the most important financial frauds in Indian stock market history. Harshad Mehta, a stockbroker from Mumbai, took advantage of many flaws in the Indian banking and stock market systems to manipulate stock prices and profit massively.

Mehta’s strategy entailed securing bank loans with forged securities as collateral and then using the proceeds to purchase massive volumes of stock. This created artificial demand for these shares, causing their prices to skyrocket. Mehta would then earn greatly by selling these shares at a high price.

Mehta’s manipulations led to a boom in the Indian stock market in the early 1990s, and his wealth and influence grew rapidly. However, his fraudulent activities came to light in April 1992 when the State Bank of India discovered that the collateral provided by Mehta’s firm, grow more Research and Asset Management, was fake.

The news caused a tremendous sell-off in the stock market, resulting in a price fall. Numerous investors lost money, and several banks and financial institutions suffered significant losses as a result of their involvement in Mehta’s fraudulent operations.

The Harshad Mehta scam caused substantial upheaval in the Indian financial sector, prompting the government to implement various changes to regulate the stock market and avoid similar scams. The fraud also prompted the formation of regulatory entities such as the SEBI and NSE to provide greater openness and accountability in the Indian stock market.

2. Importance of the Harshad Mehta Scam in the History of the Indian Financial System

The Harshad Mehta scam of 1992 is a significant event in the history of the Indian financial system, and its impact is still felt today. The scam was one of the largest financial frauds in Indian history, and it exposed several weaknesses in the regulatory and oversight mechanisms of the Indian financial system.

The importance of the scam lies in the fact that it led to significant reforms and changes in the Indian financial system. The establishment of SEBI and NSE, the introduction of electronic trading, and the tightening of banking regulations were some of the measures taken to prevent such fraud in the future.

Moreover, the Harshad Mehta scam exposed the need for greater transparency and accountability in the Indian financial system. It highlighted the risks associated with opaque financial transactions and the importance of ethical conduct in the financial industry.

The aftermath of the scam also led to a change in the public perception of the stock market and the financial sector. Investors became more cautious and discerning, and the emphasis on transparency and accountability increased significantly. The scam served as a wake-up call for regulators, investors, and market participants to take a more proactive approach to prevent such fraud in the future.

In summary, the Harshad Mehta scam was a significant event in the history of the Indian financial system, and its impact has been far-reaching. The reforms and changes implemented in the aftermath of the scam have strengthened the Indian financial system and made it more resilient to fraud and malpractices. The scam also served as a reminder of the importance of ethical conduct and transparency in the financial industry.

3. Impact of the Harshad Mehta Scam on the Stock Market

The stock market’s share values fell immediately, which caused both the BSE and NSE to completely collapse and put investors’ money at risk.

To deal with this scam, the government created a special court and put into effect an ordinance or law that included several harsh penalties. All individuals accused in this scam had their property attached by Sections 3 and 4 of the aforementioned ordinances, which also declared all deals made from them after March 31, 1991, invalid.^[1]

4. Key legal and legislative frameworks on the Harshad Mehta scam

The Harshad Mehta scam, also known as the Securities Scam of 1992, was a major financial fraud in India’s stock market. Harshad Mehta, a stockbroker, used fraudulent methods to manipulate the stock prices of various companies and made a huge profit from the scam. The Indian government and regulatory authorities took various legal and legislative measures to deal with the aftermath of the scam.

Here are some of the key legal and legislative frameworks on the Harshad Mehta scam:

The SEBI Act, 1992: SEBI was established as the regulator of the securities market in India through this Act. SEBI was given the power to regulate and monitor stockbrokers, merchant bankers, and other market intermediaries. The Act also empowered SEBI to investigate and penalize individuals and entities for insider trading, price manipulation, and other fraudulent activities in the stock market.
Banking Regulation Act, 1949: The RBI used this Act to investigate and penalize banks that had provided loans to Harshad Mehta and his associates without proper collateral. The RBI also tightened its regulations on banks to prevent such lending practices in the future.
The Securities Scam (1992) and the subsequent investigation by the JPC: The JPC was constituted to investigate the Harshad Mehta scam and recommend measures to prevent such frauds in the future. The JPC submitted its report in 1993, which led to several reforms in the Indian stock market, including the establishment of the NSE and the introduction of electronic trading.
The IPC and the PCA: Several individuals involved in the Harshad Mehta scam were charged under these Acts for various offenses, including cheating, criminal breach of trust, and corruption.

Overall, the Harshad Mehta scam led to significant changes in the regulatory framework of the Indian stock market. The government and regulatory authorities implemented several measures to prevent such frauds in the future, including the strengthening of regulations and the establishment of new institutions like SEBI and NSE.

Amendments to the Securities Exchange Board of India Act, 1992 The SEBI decided to include some amendments in the act after experiencing the major stock market crash to close the loopholes and ensure a secure future for both the stock exchange and the government. The amendments were made with the primary perspective of protecting the interests of the investors and the companies whose shares are traded in the stock market.Clause b of Chp VIA, Sec15A, states that SEBI has the authority to impose penalties on businesses that fail to submit the necessary paperwork by the deadline. These businesses are then responsible for paying the fines. Chp VII, Sect26D: According to Sec (26D), SEBI has been given the authority to provide the application of the code to proceedings before the Special Court. The amount of such penalty cannot be less than one lakh rupees, and it may increase up to one lakh per day until failure continues, which may extend up to a maximum of one crore rupees. The procedures before a Special Court shall be governed by the provisions of the 1973 Code of Criminal Procedure.^[2]

5. Judicial Response to the Harshad Mehta Scam of 1992

The judicial response to the Harshad Mehta scam of 1992 was critical in bringing the perpetrators of the scam to justice and in setting a precedent for future financial fraud cases in India. The scam involved multiple legal issues, including violations of banking regulations, securities laws, and tax laws. The following are some of the key judicial responses and ratio decidendi in the Harshad Mehta scam:

The SEBI, the regulator for the securities market, imposed penalties on the brokers involved in the scam for manipulating stock prices and violating securities regulations.
The RBI, the central bank of India, conducted an investigation into the irregularities in the banking system and imposed penalties on the banks that had issued fake bank receipts.
The Central Bureau of Investigation (CBI), the premier investigating agency of India, filed criminal cases against Harshad Mehta and other brokers for cheating, forgery, and criminal conspiracy.
The Supreme Court of India, in the case of MC Mehta V. Union of India, directed the government to set up a special court to try cases related to the securities scam. The court also directed the SEBI to take necessary steps to prevent such frauds in the future.

In conclusion, the judicial response to the Harshad Mehta scam was significant in bringing the perpetrators to justice and in setting a precedent for future financial fraud cases in India. The principles established in the Harshad Mehta cases continue to guide the Indian financial system, including the importance of regulatory oversight, strict enforcement of laws and regulations, judicial accountability, transparency and disclosure, and investor protection.

6. Related Scams or Cases

Several related cases emerged from the Harshad Mehta Scam of 1992. Some of the notable cases are:

The BSE payment crisis: In the aftermath of the Harshad Mehta scam, the BSE faced a payment crisis as several brokers defaulted on their payment obligations. The BSE had to suspend trading for three weeks in March-April 1993 to resolve the crisis.
The MMCB scam: The MMCB scam was another financial fraud that occurred in 2001 in Ahmedabad, Gujarat. The scam involved a group of stockbrokers who had colluded with the bank’s management to siphon off funds through fraudulent transactions. Some of the individuals involved in the Harshad Mehta scam were also implicated in the MMCB scam.
The Ketan Parekh scam: Ketan Parekh was a stockbroker who operated in the Indian stock market in the late 1990s and early 2000s. He used similar fraudulent methods as Harshad Mehta to manipulate stock prices and make a profit. His activities came to light in 2001 when he defaulted on payment obligations, leading to a significant fall in stock prices.
The Satyam Scandal: The Satyam Scandal of 2009 was another major corporate fraud in India that involved financial irregularities, falsification of accounts, and insider trading. The scandal led to the collapse of Satyam Computer Services, one of India’s leading IT companies. Some of the individuals involved in the Harshad Mehta scam were also implicated in the Satyam Scandal.
Sahara Scam: The Sahara Scam involved two Sahara Group companies, Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited, which had raised funds from the public in violation of securities regulations. The SEBI ordered the companies to refund the funds, but they failed to do so, leading to a long legal battle between SEBI and the Sahara Group.
NSEL Scam: The NSEL Scam involved the NSEL, a commodity exchange in India, which had launched a spot exchange for commodities trading. However, the exchange was found to be trading in non-existent commodities and had failed to settle the contracts. The scam led to several arrests and legal action against the individuals and entities involved in the fraud.

These related cases highlighted the need for stronger regulatory mechanisms and ethical conduct in the Indian financial system. Regulatory bodies like SEBI and the RBI have since introduced several measures to prevent such fraud in the future.

7. Lessons Learned from Related Scams or Cases

The BSE payment crisis:

The BSE payment crisis taught several valuable lessons to the Indian financial system, including the importance of settlement systems, effective risk management, regulatory oversight, transparency, and technology. These lessons have helped to strengthen the Indian financial system and make it more resilient to future crises.

The MMCB scam:

The MMCB scam taught several valuable lessons to the Indian banking system, including the need for stronger regulatory oversight, effective corporate governance, risk management, transparency, and technology. These lessons have helped to strengthen the Indian banking system and make it more resilient to future frauds and malpractices.

The Ketan Parekh scam:

The Ketan Parekh scam taught several valuable lessons to the Indian stock market, including the need for stricter regulation of stock market operators, diversification and risk management, transparency and disclosure, investor education, and technology. These lessons have helped to strengthen the Indian stock market and make it more resilient to future frauds and market manipulations.

The Satyam Scandal:

The Satyam scandal taught several valuable lessons to the Indian corporate sector, including the importance of independent auditors, effective corporate governance, whistle-blowers, transparency and disclosure, and stricter enforcement of regulations. These lessons have helped to strengthen the Indian corporate sector and make it more resilient to future frauds and malpractices.

Sahara Scam:

The Sahara scam taught several valuable lessons to the Indian financial sector, including the need for stronger regulation of NBFCs, investor protection, technology, stricter enforcement of regulations, and transparency and disclosure. These lessons have helped to strengthen the Indian financial sector and make it more resilient to future frauds and malpractices.

NSEL Scam:

The NSEL scam taught several valuable lessons to the Indian commodities market, including the need for stronger regulatory oversight, transparency and disclosure, independent audits, technology, and investor protection. These lessons have helped to strengthen the Indian commodities market and make it more resilient to future frauds and malpractices.

8. Conclusion

The Harshad Mehta Scam of 1992 was a wake-up call for the Indian financial system, highlighting the loopholes and inadequacies in the regulatory framework of the stock market and the banking sector. The scam resulted in significant losses for investors, banks, and financial institutions, and it shook the confidence of the general public in the Indian financial system.

However, the aftermath of the scam also led to significant reforms and changes in the regulatory landscape of the Indian stock market. The establishment of regulatory bodies like SEBI and NSE, the introduction of electronic trading, and the tightening of banking regulations were some of the measures taken to prevent such fraud in the future.

The Harshad Mehta scam also raised important ethical questions about the role of stockbrokers, regulators, and other market intermediaries in ensuring fair and transparent dealings in the stock market. It highlighted the need for greater transparency, accountability, and ethical conduct in the financial industry.

Overall, while the Harshad Mehta scam was a painful episode in the history of the Indian financial system, it also catalyzed much-needed reforms and changes that have strengthened the system and made it more resilient to such frauds in the future.

^[1]K. Geetha Vaishnavi; Black n’ White Journal.com ;2020;last accessed on 25^th March 2023;available at https://bnwjournal.com/2020/10/04/revisiting-the-stock-market-scam/.

^[2]Astha Agarwal; Universe International Journal of Interdisciplinary Research ;Vol. 1 Issue 12; Iss no.2582-6417,May 2021, last accessed on 23^rd March;2023;available athttps://uijir.com/wp-content/uploads/2021/05/4-UIJIR-21304-1.pdf