HARSHAD MEHTA : THE BAAP OF BANK FRAUDS

Bernard Baruch , an American stock investor and political consultant once said : "The main purpose of the stock market is to make fools of as many men as possible." This quote is very apt, especially in the light of the Rs. 4,000 - crore Harshad Mehta -The Security Scam. Adjusted for inflation today, Harshad Mehta fraudulently laundered over Rs. 24000 crore in the stock market over a three-year period. So, how did Harshad Mehta pull off a multi crore scam in the Indian stock market? What happened to those accused in the scam ,including the original Big Bull of Dalal Street , that is, Harshad Mehta himself? Was the money ever recovered? Were the fraud cases, being contested in the court, ever came to a meaningful conclusion? So, today let's talk about the man whose story is nothing short of a bollywood movie.

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 Who was Harshad Mehta

• Harshad Shantilal mehta was born on 29 july 1954 ,at Paneli Moti ,Rajkot district, in a Gujarati Jain family.
• Born in middle class, Mehta studied in Holy Cross Byron Bazaar Higher Secondary school in Raipur but he did not show any special promise in school.
• He migrated to Mumbai with just Rs 40 in his pocket for further studies and in 1976 he somehow managed to complete his graduation in commerce from Lala Lajpat Rai College,Mumbai.
• After graduation, he worked a number of odd jobs for the next eight years. 

His Early Career

• Mehta struggled a while taking low level jobs related to sales , including selling hosiery, cement , and sorting diamonds.
• At that time he had no idea about what he was going to do in his life but he kept exploring and his luck turned around when he joined New India Assurance Company Limited(NIACL) as a salesperson.
• During this time, he got interest in the share market and after a few years, resigned and joined the stock broker B.Ambalal. 
• Later in 1981 he worked as sub-broker to stock broker J.L.Shah and Nandalal Sheth.
• He realised that this is the game he was born to play.
• Over a period of ten years, beginning 1980, he served in positions of increasing responsibility at a series of brokerage firms.

 

Transition  from  an Ordinary Broker  to "Big Bull"

• In 1984 , Mehta was able to become a member of the Bombay Stock Exchange as a broker and established his own firm called Grow More Research and Asset Management, with the financial assistance of associates , when the BSE auctioned a brokers card.
• In 1986, he started trading actively.
• By early 1990, he became a famous stock broker and a number of eminent people began to invest in his firm, and utilize his services including the then minister P.Chidambaram through Chidambaram's own shell companies.
• By 1990,the media(including popular magazines such as Business Today)portrayed a heightened deified image of Mehta, calling him " The Amitabh Bachchan of Stock market."
• But he was not satisfied with his success,he had bigger ambitions, so in this lust for money he started exploring various loopholes in the Indian banking system.
• At that time, the Reserve Bank of India has mandated all the banks to retain a certain ratio of their assets in government fixed interest bonds by the end of each week failing which the RBI would penalise them.
• Mehta cleverly squeezed capital out of the banking system to address this requirement of banks and pumped this money into the share market and had been buying stock heavily.
• Mehta's favourite stocks included Associated Cement Company(ACC), Apollo Tyres, Reliance, Hero Honda, Tata Iron and Steel Co.(TISCO), BPL, Sterlite and Videocon, to name a few.
• The ACC, India's foremost cement firm, was Mehta's favourite.
• He pumped money into its shares so aggressively that its stock rose from Rs. 200 a share to Rs. 9000 a share in three years - a 4400 % rise!
• For those who asked, Mehta had the replacement cost theory as an explanation. 
• The replacement cost theory basically states that older  companies should be valued on the basis of the amount of money that  would be needed to create another similar company.
• By the latter half of  1991, Mehta had come to be called the ‘Big Bull’ as people credited him  with having initiated the Bull Run.

The Scam that Shook India!!

SO WHAT EXACTLY THE HARSHAD MEHTA DID? HOW WAS MEHTA MAKING THE MONEY?

AND WHICH INSTRUMENTS WERE USED IN THE SCAM?

• Harshad Mehta used the technique of the Ready Forward Deal in scam.
• Ready forward deal is a secured short term loan which is given from one bank to another bank for Ready forward deal is a secured short term loan which is given from one bank to another bank for 15 days.
• Basically government need funds for infrastructure projects and other expenses so government compelled the banks to maintain a particular amount of their deposits in government bonds.
• This ratio was called as the SLR(Statutory Liquidity Ratio).
• Whenever government needed funds, it used to sell its securities in the market and banks needed to buy it which blocked the liquidity of banks.
• So when this liquidity is blocked, then banks have another choice that banks can sell their government securities in form of ready forward deal to another bank and in turn get money.
• Lets try to understand it better with the help of an example.
• Suppose there are two banks -Bank A and Bank B.
• Now Bank A(the borrower bank) due to its liquidity blockage is in need of money and Bank B(the lending bank)have sufficient funds with them and is ready to advance money to Bank A.
• So,Bank B will lend money(short term loan) to Bank A against the government bonds of Bank A acting as a collateral security.
• But this transaction of borrowing and lending between the two banks takes place with the help of a mediator, that is, the broker.
• The broker usually brings together two banks for deal and against this he gets commission.
• The securities and payments were delivered through the broker and in such settlement banks may not know with whom they are dealing.
• Harshad mehta took advantage of this only.
• The bank(Bank A) who needed money used to approach Mehta and gave him their government securities and in turn Mehta would ask them for some time to make the necessary arrangements. 
• Since Mehta was so influential the banks did not mind waiting for a few extra days.
• Meanwhile, he would find the buyer bank(Bank B) who would advance money against the securities of the seller bank(Bank A).
• As per the norms of banking the buyer bank(Bank B) should transfer money directly in the name of the seller bank (Bank A).
• But Mehta asked the buying bank(Bank B) to transfer the funds in his own name and since he has built so much trust in business, the banks started issuing cheques in his own name which was illegal. 
• During that time he had all this massive cash in his personal account and he was investing that money into the stock market.
• He just pick some shares of the company and kept buying those shares aggressively and because of this massive liqiuidity injection the share price of these stocks would go up.
• He had the touch of Midas : everything he touched became gold and thousands of gullible investors followed his lead which raised the stock prices even higher.
• All this time, the seller bank (Bank A) was still thinking that Mehta is trying to arrange for a buyer bank.
• They did not even know that their(Bank A) securities were already transferred to another bank(Bank B) and the money was lent in the name of Harshad Mehta.
• Now the question arises that if the money was being pumped into the share market then how was Mehta making payment to the seller bank(Bank A)?
• Here is where his cleverness came in.
• When the seller bank(Bank A) continously poked Mehta for the money, then he used to sell his shares in the market at a much higher price and made the payment to the concerned bank.
• As long as the market was in Bull phase, Mehta didn't face any problem in making payment to the banks.
• All of this was going very well and till this time the scam was not that big.
• The scam went big when his greed for money increased and the fake Bank Receipts(BRs) came into picture.
• The seller bank, that is, the borrower(Bank A) used to issue a bank receipt to the buyer bank, that is, the lender(Bank B) as a confirmation of sale of securities.
• Bank receipt acts as a receipt for the received money by the selling bank, that is, the borrower(Bank A).
• Mehta needed banks which could issue fake bank receipts and so he conspired with the officials of two banks namely Bank of Karad(BOK) and Mumbai Mercantile Co-operative bank to issue bank receipts that were not backed up by any government bonds.
• These fake bank receipts were nothing more than just a piece of paper.
• Once these fake bank receipts(BRs) were issued, they were passed on to other banks and banks in turn gave money to Mehta plainly assuming that they were lending against government security when this was not really the case.
• The money he got was used to drive the prices of the stock in the stock market and when the time came to return the money , shares would be sold for a profit and the fake BRs were retired.
• The game went on as long as the stock prices kept going up and no one had a clue about Mehtas' modus operandi.
• He swindled around 4000 crore rupees in this manner from the banks and manipulated around 90 stocks.
• This extensive liquidity gave an adrenaline shot to the stock market in general and the market began to make major hopes.
• In fact , Bombay Stock Exchange quadrupled its index(Sensex) in a span of just one year and because of that Mehtas' own portfolio of stock holdings gained in the value close to 10 times to an estimated to 100 crore rupees. 
• All this money made Mehta a hero in stock market and he became the highest taxpayer in Mumbai at that time.

EXPOSURE & ARREST

• Harshad Mehta lived a very luxurious lifestyle and was never shy to show off his wealth.
• He bought a 12,000 square feet sea - facing Worli penthouse, complete with a mini golf course and swimming pool and used to drive Toyota Lexus car which has just been released internationally and costed more than Rs. 40 lakhs at that time.
• His fleet of two dozen luxury cars marked his steep and sudden rise to riches and celebrity - status.
• He even paid the Income Tax Department an advance tax of Rs 26 crore just weeks before the scandal broke. 
• Sadly, all this show off and blind greed got him into trouble.  
• On 23 April 1992, an investigative journalist Sucheta Dalal got hint of Mehta's illicit methods and she wrote an article in The Times of India detailing the loopholes in the banking system that had been exploited by the stock - broker which was the beginning of Mehta's end.
• Following this , the State Bank of India realised it was holding onto worthless bank receipts and was owed Rs. 500 crore by Harshad.
• By the end of April 1992, he was accused of having diverted money from the public sector Maruti Udyog Limited (MUL) to his own accounts and the lending banks began to ask for money from Mehta.
• Paying money back was never a problem for Harshad Mehta because he would just sell his shares in the stock market and thus fulfilling his obligations.
• But this time it was different because as soon as the scandal broke out, the stock market crashed drastically and the value of Mehta's share dropped steeply and he had no way to repay the banks.
• It did'nt take much time for CBI to step up and on 9th November,1992 Mehta  and his brothers , who masterminded and executed this scam together was arrested.
• But Mehta and his brothers were released on bail after three months in custody. 

REGULATORY ACTIONS TAKEN AGAINST MEHTA

• The CBI charged Mehta specifically with 72 criminal cases (bribery,cheating,forgery,criminal conspirany and falsification of accounts) and over 600 civil action suits by banks and institutions pertaining to monies he owed them.
• Of the 27 criminal charges brought against him, he was only convicted of four , before his death at age 47 in 2001.
• The market watchdog - Securities Exchange Board of India(SEBI)  banned him for life from stock market related activities with investors holding him responsible for causing a loss to various entities.
• Alongside, the Reserve Bank of India appointed a joint parliamentary committee(JPC) , also known as the Janakiraman Committee, to provide a comprehensive picture of the mechanics of the fraud.

 

COMEBACK OF MEHTA

• Once out on bail, several stock market investors gave Mehta a hero's welcome.
• Mehta made a brief comeback as a stock market guru, giving tips on his own website as well as in a weekly newspaper column.
• Weeks after comeback, Mehta along with his lawyer Ram Jethmalani in a press conference claimed that he paid Rs. 1 crore to then Prime Minister PV Narasimha Rao as donation to the Congress Party, for getting him off the scandal case.
• He even displayed the suitcase in which he allegedly carried the cash.
• Rao denied it, and later, a CBI probe also found no concrete evidence of this bribery claim.
• Despite the promptness shown by CBI and the JPC in uncovering this fraud , it took a while to put together criminal evidence against Mehta.
• Finally in September 1999, Bombay High Court convicted and sentenced him to five years rigorous imprisonment and a fine of Rs. 25000.
• On 14 January 2003, Supreme Court of India confirmed High Court's judgement. 

DEATH OF MEHTA

• Mehta was under Criminal custody in the Thane prison.
• Mehta complained of chest pain late at night and was admitted to the Thane civil Hospital.
• He died following a brief heart ailment, at the age of 47, on 31 December 2001.  

IMPACT OF SCAM ON THE MARKET

• Due to Harshad Mehta Scam, Sensex fell from 4500 to 2500 loosing Rs. 100,000 crore in market capitalisation.
• Mehta also took down a lot of senior officials with him. 
• The chairman of Vijaya Bank, who had issued the cheques in name of Harshad Mehta, realised that the BR receipts given by Mehta were fake and hence committed suicide immediately after scam was exposed due to depression. 
• The top treasury officials of State Bank of India and the chairman of UCO Bank  all lost their jobs.
• But the most tragic of all  was the thousands of investor lost their hard earned money and went bankrupt and once a hero of the stock market turned out to be the greatest villian for those investors.
• The liberalization policies were put on hold by the government and Bank Receipt was removed by RBI.
• Post Mehta scam in 1992, the Government of India passed " SEBI Act 1992" and conferred statutory power to it.

THE FINAL VERDICT

• The raging bull of the stock market, Harshad Mehta who perpetrated the biggest stock market scam worth Rs.4000 crore is in the news again reviving memories of 1992 security scam that shook the country and changed the rules of the game on Dalal Street.
• In good news for his family, the ITAT reversed an order of the Income Tax Department and scrapped additions to income worth little over Rs. 2000 crore and have made relevant observations.
• The ITAT while scrapping the additions made by the IT department for the asessment year 1992-93 made an observation that every receipt of money cannot be termed as the taxable income by default.
• And it is the job of the department to compute the correct taxable income embedded in every transaction.
• The tribunnal reiterated that this principle of taxation must be followed notwithstanding the magnitude of the scam and inspite of probes and observation made by the JPC, the RBI, the CBI and the seizure of volumes of documents by the IT department.   

CONCLUSION

• The name of Harshad Mehta will live on in memory not only because of the havoc he unleashed on investor's wealth but because he revealed gaping holes in India's financial system.
• Between 1998 and 1992 SEBI began maturing and in year 1992 it was forced to speed up the process and embark on a steep learning curve -- thanks to Harshad Mehta and his associates.
• People often say that "What doesn’t kill you, makes you stronger" -- words that have been true for market regulator SEBI who learned from these lapses and emerged keener and stronger.
• This scam also teaches us that when the valuations of the company start to get on the crazy side the smart investors should start getting cautious instead of getting greedy.  
• So, if you become a critical thinker who takes no Dalal Street "fact" on faith, and you invest with patient confidence, you can take steady advantage of even the worst bear markets.
• In the end, how your investments behave is much less important than how you behave.

FOR INDEED, THE INVESTOR'S CHIEF PROBLEM -- AND EVEN HIS WORST ENEMY -- IS LIKELY TO BE HIMSELF!

 ("The fault, dear investors, is not in our stars -- and not in our stocks --but in ourselves….")

Sources:  www.thequint. com                           

              www .forbesindia. com                     

              www.economictimes.indiatimes. com 

!! I hope it was helpful !!

-By Nimisha Salampuria

Mail at nimisha@commerceinsiders.com

For further information contact at info@commerceinsiders.com

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