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CHAPTER I
Introduction and Research Methodology
INTRODUCTION:
Various scams, scandals and stigmas have surfaced in the recent years. These may not all be
attributable to the antics and bungling of politicians, but they have been facilitated largely
because of the vitiated atmosphere that the politicians and the political system have created in the
country.
The “Securities Scam” refers to a diversion of funds to the tune of Rs. 5,000 crores from the
baning system to various stocbroers in a series of transactions !primarily in "overnmentsecurities# during the period $pril %&&% to 'ay %&&(.
)There*s this theory about the ne+t fool around the corner,) says G.V. Ramakrishna. )ut -e may
not have an ine+haustible supply of fools, the men -ho are left holding the can -hen there*s
nobody at all to pay a higher price.)
$s the rapidly breaing scandal in the finance marets and the share baaar spreads, the
Securities and /+change oard of ndia chairman*s comment appears to be right on target.
1ith one modification2 people lie stocbroer 3arshad 'ehta don*t need an ine+haustible
supply of fools. 4ust adeuate -ill do. This, and the added advantage of being at the right place atthe right time -ith the right game plan, could only be a -inning combination.
t -as. 6or him, and anybody associated -ith him. ut no- that the game has come unstuc, it is
becoming clear that the flamboyant 789year9old 'ehta, a fast9taling, fast9dealing high9roller is
at the centre of the biggest financial and insider trading scam ever in the country*s history.
The money involved in the past one year alone could be as much as Rs :,000 crore or more,
taen from bans in various -ays to play the booming stoc9marets.%
1 http://indiatoday.intoday.in/story/securities-scam-harshad-mehta-throws-banking-
system-stock-markets-into-turmoil/1/306969.html visited on 3 pril !" #016 at #.1$
pm
http://indiatoday.intoday.in/story/securities-scam-harshad-mehta-throws-banking-system-stock-markets-into-turmoil/1/306969.htmlhttp://indiatoday.intoday.in/story/securities-scam-harshad-mehta-throws-banking-system-stock-markets-into-turmoil/1/306969.htmlhttp://indiatoday.intoday.in/story/securities-scam-harshad-mehta-throws-banking-system-stock-markets-into-turmoil/1/306969.htmlhttp://indiatoday.intoday.in/story/securities-scam-harshad-mehta-throws-banking-system-stock-markets-into-turmoil/1/306969.html
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1! O"#ECTI$E O% THE &TUD'
The research pro;ect has been carried out -ith the follo-ing ob;ectives2
The basic ob;ective behind carrying out this research pro;ect is to study about securities
scam -ith reference to 3arshad 'ehta scam To no- about causes of the scam and its impact on ndian economy.
1( RE&EARCH METHOD)O*'
The uality and value of research depends upon the proper and particular methodology adopted
for the completion of research -or.
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CHAPTER II
HAR&HAD MEHTA &CAM
!1 "RIE% A"OUT HAR&HAD MEHTA
3arshad Shantilal 'ehta -as born on (& 4uly in a "u;arati 4ain family of modest means.
6ather 2 'r Shantilal 'ehta, a small businessman
'oved from small to-n Raipur to find his future in 'umbai
6irst ;ob as dispatch cler in the >e- ndia $ssurance
1ored -ith stoc broers and soon managed to get a broers? card
Soon started his o-n venture2 "ro- 'ore Research and $sset 'anagement @ompany
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3e -as later charged -ith 8( criminal offenses and more than :00 civil action suits -ere filed
against him
3e died in (00( of a massive heart attac in a ;ail in Thane, -ith many litigations still pending
against him.
!! O$ER$IE+ O% THE &CAM
This scam can be categoried as a @apital 'aret scam in -hich it is done by manipulating the
facts in order to attain enormous profits. There -ere D different aspects of this scam2
Civersion of 6unds
ntra9day Trading
Ese of Ready 6or-ard!R6# to maintain S
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Taing advantages of the loopholes in the baning system, 3arshad and his associates triggered a
securities scam diverting funds to the tune of Rs D000 @r. from the bans to stocbroers from
$pril %&&% to 'ay %&&(. 3e caused the steep rise in the Stoc maret inde+ in the year %&&( by
bidding at a premium for many shares.
Some of the stocs -hich -ere highly invested in by 3arshad 'ehta -ere2
$@@
$pollo Tyres
Reliance
Tata ron and Steel @o. !TS@B#
A<
Sterlite
Videocon
!( READ' %OR+ARD ,R%- . MODU& OPERANDI
Ready for-ard is actually a sort of a short term loan !typically %5 days or less# usually from one ban to another. Enlie other loans, it is actually a secured loan -ith "overnment securities
bacing it up. n essence, it?s lie one ban selling its securities to another -ith a promise of
buying it bac at a pre9determined price.
n early %&&0s, ans in ndia had to maintain a fi+ed ratio of their deposits in the form of
"overnment securitiesFbonds -hich -as governed by the statutory liuidity ratio !S
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by selling the bonds. The -hole process of byying and selling the bonds -as taen care of by
broers and only they ne- the t-o parties -hich -ere involved. ndividual bans did not have
any idea as to -ho the other party in the -hole transaction -as.
The -hole process can be described in 7 phases2
Settlement Arocess
Aayment cheues
Cispensing of securities
!/ &ETT)EMENT PROCE&&
The normal settlement process in government securities is that the transacting bans mae
payments and deliver the securities directly to each other. Curing the scam, ho-ever, the bans
or at least some bans adopted an alternative settlement process -hich -as similar to the process
used for settling transactions in the stoc maret.
n this settlement process, deliveries of securities and payments are made through the broer.
That is, the seller hands over the securities to the broer -ho passes them on to the buyer, -hile
the buyer gives the cheue to the broer -ho then maes the payment to the seller.
n this settlement process, the buyer and the seller may not even no- -hom they have traded
-ith, both being no-n only to the broer.
There -ere t-o important reasons -hy the broer intermediated settlement began to be used in
the government securities marets2
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The broers instead of merely bringing buyers and sellers together started taing positions in the
maret. n other -ords, they started trading on their o-n account, and in a sense became maret
maers in some securities thereby imparting greater liuidity to the marets.
1hen a ban -anted to conceal the fact that it -as doing an R6 deal, the broer came in handy.
The broer provided contract notes for this purpose -ith fictitious counter parties, but arrangedfor the actual settlement to tae place -ith the correct counter party.
!0 PA'MENT CHEUE&
$ broer intermediated settlement allo-ed the broer to lay his hands on the cheue as it -ent
from one ban to another through him. The hurdle no- -as to find a -ay of crediting the cheue
to his account though it -as dra-n in favor of a ban and -as crossed account payee. $s it
happens, it is purely a matter of baning custom that an account payee cheue is paid only to the
payee mentioned on the cheue. n fact, e+ceptions -ere being made to this norm, -ell before
the scam came to light.
Arivileged !corporate# customers -ere routinely allo-ed to credit account payee cheues in
favour of a ban into their o-n accounts to avoid clearing delays, thereby reducing the interest
lost on the amount.>ormally, if a customer obtains a cheue in his o-n favour and deposits it
into his o-n account, it may tae a day or t-o for the cheue to be cleared and for the funds to
become available to the customer. $t %5G interest, the interest loss on a clearing delay of t-o
days for a Rs. %00 crores cheue is about Rs. H lahs.
Bn the other hand, -hen bans mae payments to each other by -riting cheues on their account
-ith the R, these cheues are cleared on the same day.
The practice -hich thus emerged -as that a customer -ould obtain a cheue dra-n on the R
favoring not himself but his ban. The ban -ould get the money and credit his account the same
day.
The broers ased the bans to give the cheues in their o-n name claiming that they -ill pay to
the other party on their o-n. The practice thus emerged -as that the broer -ould obtain a
cheue dra-n on the R favouring not himself but his ban and the ban -ould get the money
and transfer it to the broer account on the same day. This helped the broers to get the money as
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soon as the transaction is made -hich could further be used to be channelled into the stoc
maret.
!2 DI&PEN&IN* O% &ECURITIE&
3ere the broers used their credibility to persuade the bans to part -ith the cheues -ithout
actually receiving the securities -ith the promise that they -ill get the securities the ne+t day
-ith a %5G interest for one day. an officials -ere bribed to accomplish this tas as this -as
illegal on the part of the bans to let go of their money -ithout any assurance. This -as 3arshad
'ehta and his associates -ere able to use the money of the bans -hich -as eventually used for
speculating in the stoc maret.
!3 "AN4 RECEIPT&
$nother instrument used in this scam -as the ban receipt !R#. n an R6 deal, securities -ere
not moved bac and forth in actuality. nstead, the borro-er, -ho is the seller of securities, gave
the buyer of the securities a R.
n practice, borro-ing ban gives a an Receipt !R# instead of delivering the actual securities
to the lender. an receipts serve three functions =
t confirms the sale of securities
Aromises to deliver the securities to the buyer. t states that the securities are held by the seller in
trust for the buyer.
$cts as a receipt for the received money by the selling ban
$ R means that the issuer holds the securities in trust for the buyer, but there is a possibility
that the issuer may not have the securities at all. 6ollo-ing are the reasons for a ban to issue aR -hich is not baced by actual securities =
$ ban may also short sell securities, i.e. ban -ill sell securities it doesn?t have.
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This -ill be done if the ban anticipates fall in prices. an buys securities at lo-er prices -hen
they fall in value and discharges the R.
an may do an R6 deal and issue a fae R !not baced by securities# if bans simply -ant an
unsecured loan , -here a lending ban -ould be under the impression that it?s dealing -ith a
secured loan but in reality it?s advancing an unsecured loan. Though, lenders should have taen
measures to protect themselves .
Curing the scam, broers -ere so perfect in the art of using fae Rs and obtained unsecured
loans from various bans. They managed to persuade little no-n ban s lie the an of Iarad
!BI# and the metropolitan @ooperative an !'@# to issue Rs and then these Rs -ereused to do R6 deals -ith other bans. This -ay several large bans made huge unsecured loans
to these bans and thus it created money for the broers.
!5 CONTRO) &'&TEM&
There -as a complete breado-n of the control system -ithin the commercial bans and that of
R. 6ollo-ing features are involved in the internal control system2
1henever an R6 deal is done by using Rs rather than actual securities, the lending ban has to
contend -ith the possibility that it may be maing an unsecured loan. This reuires assigning
credit limit to the borro-er by assessing the credit-orthiness of the borro-er.
The different aspects of securities transactions of a ban are carried out by different persons
!6 DI&APPEARANCE O% MONE'
t is becoming increasingly clear that despite the intensive efforts by several investigating
agencies, it -ould be impossible to trace all the money s-indled from the bans. $t this stage -e
can only con;ecture about -here the money has gone and -hat part of the misappropriated
amount -ould be recovered.
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!17 UNETHICA) I&&UE& IN MEHTA &CAM
maginary companies created.
ought the shares of o-n company by himself causing Sense+ up.
Aurchased 3uge amount of shares of a targeted company lie $@@ .
@aused false bull run.
@reated fae Rs, or Rs not baced by any government securities.
llegally issue of R by small ban.
1ithout verification, bans lie “Vi;aya an” issued the cheue.
Recommendation to purchase particular shares on his o-n -ebsite.
CHAPTER III
IMPACT O% THE &CAM
(1 IMMEDIATE IMPACT A%TER &CANDE)
$fter the 3arshad 'ehta scandal -as e+posed, $pril, %&&(, the situation in share maret -as that
of utter chaos. The first impact of the scam -as a steep fall in the share prices. The inde+ fell
from D500 to (500 representing a loss of Rs. %00,000 crores in maret capitaliation. 3o-ever,
the ma;or damage to the stoc maret did not stop here. Since the accused -ere active broers in
the stoc marets, they had traded a large number of shares during the previous year. $ll theseshares became tainted and -orthless and could not be used in the maret. This -as a great loss to
the innocent investor -ho had bought these shares much before the scandal -as e+posed.
(! IMPACT ON THE INDIAN ECONOM'
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There -as a lot of media coverage on the scam and the political parties left no opportunity in
criticiing the government for it. The government -as under immense pressure and its
liberaliation policies -ere severely criticied. t -as also believed that 3arshad 'ehta and his
accomplices -ere behind framing of these policies. n the end the government had to put the
liberaliation plans on hold. S/ had to postpone the sanctioning of private sector mutual funds.
mplementation of some aspects of the >arasimham @ommittee recommendations on the
baning system had to be delayed. The much taled about entry of foreign pension funds and
mutual funds became more remote than ever. The /uro9issues planned by several ndian
companies -ere delayed since the ability of ndian companies to raise euity capital in -orld
marets -as severely compromised.
(( IMPACT ON THE "AN4&
6ae ban receipts !R# -hich -ere an integral part of the e+ecution of the -hole scam landed
the bans involved in a tight spot. These R -ere declared void and public money -as at stae.
$t least ten prominent bans -ere involved in thisJ some of them being S, Standard @harteredand a subsidiary of R. The scam could have been checed in time -ith proper policies and
verifications. The government, the R and the commercial bans are as much accountable as
the broers for the scam. The broers -ere encouraged by the bans to divert funds from the
baning system to the stoc maret. The R too stood indicted because despite no-ledge
about bans over9stepping the boundaries demarcating their arena of operations, it failed to
chec them. Some of the prominent individuals -ho -ere penalied -ere I. '. 'argabandhu,
@'C of the E@B an !$rrested and saced# and V. 'ahadevan, one of the 'C the State an
of ndia !Suspended#
(/ RE&PON&E O% THE *O$ERNMENT
$s discussed, the government -as under immense pressure from media and opposition to tae
concrete steps to bring ;ustice to the people and also to ensure that the loopholes in the system
-hich caused such scam -ere closed so that such scams -ould not recur. $s a first step by the
government, the case -as handed over to @entral ureau of nvestigation and the 4oint
Aarliamentary @ommittee !4A@#. Then a special court -as set up to facilitate speedy trial. The
special court declared an ordinance for the attached the properties of all individuals accused in
the scam. 6urther, all transactions done by the accused after 'arch 7%, %&&% -ere considered
void. To reform the system further, the government banned R6 deals and slo-ed do-n the
liberaliation process.
(0 PO)IC' MEA&URE&
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The government, the R and the commercial bans -ere as much accountable as the broers for
this scam. The broers -ere encouraged by the bans to invest their funds in the stoc maret in
place of investing in the baning system. The R -as also responsible for this scam because
despite no-ledge about bans over9stepping the boundaries demarcating their arena of
operations, it failed to reign them in. R didn?t tae any action against the commercial bans.
The looting -as done -ith full no-ledge of the very individuals appointed by the government
-ho -ere responsible to guard against such a possibility. So the 3arshad 'ehta?s scam could
have been detected earlier if either of the above !commercial bans, R or government# parties
not encourage the broers to invest in the stoc maret.
(2 ACTION& TA4EN "' THE *O$ERNMENT:
Discover the guilty
This tas -as assigned to the @entral ureau of nvestigation !@# and to the 4oint
Aarliamentary @ommittee !4A@#. $ special court -as set up to facilitate speedy trial.
Transactions became void
The government set up a special court and promulgated an ordinance -ith several draconian
provisions to deal -ith the scam. Sections !7# and !D# of the ordinance attached the properties of
all individuals accused in the scam and also voided all transactions that had at any stage been
routed through them after 'arch 7%, %&&%.
Recover the money
Arovisions of the Brdinance for attachment of property and voiding of transactions -ith the
conseuent creation of )tainted) shares -ere attempts in this direction
Reform the system
The government*s response so far, banning of R6 deals and going slo- on liberaliation. The
main motive behind punishing the offenders is more to prevent future offenders to not to try this
type of scam. The government must ensure that not only the obviously guilty !the broers# but
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also the not so obviously guilty !the ban e+ecutives, the bureaucrats and perhaps the politicians#
are identified and brought to boo. These types of investigations are not only very time
consuming but also very e+pensive.
3.7 ROL OF !"I #T$I%&L I!!'!(
The S/ -as set up in early %&HH as a non statutory body under an administrative arrangement
and -as subseuently upgraded as a fully autonomous body on %(th of $pril %&&(
The t-o ob;ective s mandated in the S/ $ct are
nvestor protection
Brderly development of capital maret
(5 #UD*EMENT
3e -as later charged -ith 8( criminal offenses and more than :00 civil action suits -ere filed
against him. y the time he died , 'ehta had been convicted in only one of the many cases filed
against him. 3e died in (00( of a massive heart attac in a ;ail in Thane, -ith many litigations
still pending against him.
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CHAPTER I$
CONC)U&ION
@orporate "overnance is the value frame-or, ethical frame-or and moral frame-or -ithin
-hich businesses mae decisions .1hen large sums of money are involved, greed causes people
to become unethical. There -as a total lac of transparency in the money maret. rregularities of
all ind -ere so common that no suspicion aroused even by highly irregular transactions. This is
the ideal environment for a scam to germinate and gro- to alarming proportions. The most
constructive response to the scam -ould be in the arena of reforms of the financial system. n our
vie-, the origins of the scam lie in over9regulation of our marets. The regulations in the money
marets -ere such that thoroughly legitimate and essential transactions could not be put through
openly, but had to be disguised and camouflaged. The role of the broers and of some of the
bans as maret maers -as not recognied and they could perform these important and useful
functions only by subterfuge. The payment and clearance system -as so antiuated and
cumbersome that totally indefensible methods had to be adopted to achieve speedy funds
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transfers. The net result of all these -as a total lac of transparency in the operations in the
money maret. rregularities of all inds -ere so common that no suspicions -ere aroused even
by highly irregular transactions. The situation -as an ideal environment for a scam to germinate
and gro- to alarming proportions. 1e -ould even argue that some of the control systems in the
bans broe do-n because they had been deliberately allo-ed to -eaen by both the commercial
bans as -ell as the R in order to facilitate normal transactions in violation of the R
guidelines.
"I")IO*RAPH'
RE%ERENCE&
K http2FFen.-iipedia.orgF-iiF3arshadL'ehta
K http2FF---.bullrider.inFharshad9mehta9stoc9scamF
K http2FFinvestmentpar.blogspot.comF(008F0(Fharshad9mehta9scam9%&&(.html
K http2FF---.scribd.comFdocF%8((8(%5F3arshad9'ehta9Scam
K http2FF-ii.ans-ers.comFMF@anLyouLgiveLtheLdetailsLaboutLtheL3arshadL'ehtaLsca m
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K http2FF---.authorstream.comFAresentationFpratmL%H9DH:(:89harshad9mehta9and9etan9
pareh9scamF
K http2FF---.slideserve.comFAAT6ilesFinsightsLinvestingL;ul0HL(&5D(L7(D(D.ppt
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