1992 Indian stock market scam

The **1992 Indian stock market scam** was a market manipulation carried out by Harshad Mehta and other bankers and politicians on the Bombay Stock Exchange. The scam caused significant disruption to the stock market of India, with over one billion USD defrauded.

Techniques used by Mehta involved having corrupt officials signing fake cheques, market loopholes, and lies to drive the prices of stocks up to 40 times their original price. Stock traders making good returns as a result of the scam were able to fraudulently obtain unsecured loans from banks. When the scam was discovered in April 1992, the Indian stock market collapsed, and the same banks suddenly found themselves holding millions of INR in now useless debt.

## Scam 1992

### Overview

The 1992 scam was the biggest Money Market scam ever committed in India. The main perpetrator of the scam was stockbroker & Money Market Broker Harshad Mehta. It was a systematic stock fraud using bank receipts and stamp paper which caused the Indian Stock market to crash. The scam exposed the inherent loopholes of the Indian financial systems (Money Market) and resulted in a completely reformed system of stock transactions and an introduction of online security systems.

Security frauds refer to the idea of diversion of funds from the banking system to various stockholders or brokers. The 1992 scam was a systematic fraud committed by Harshad Mehta in the Indian stock market which made the entire securities system collapse. Mehta committed a fraud of over 1 billion from the banking system to buy stocks on the Bombay Stock Exchange. This impacted the entire exchange system as the security system collapsed and investors lost thousands of rupees in the exchange system. The scope of the scam was so large that the net value of the stocks was higher than the health budget and education budget of India. The scam was orchestrated in such a way that Mehta secured securities from the State Bank of India against forged cheques signed by corrupt officials and failed to deliver the securities. Mehta made the prices of the stocks soar high through fictitious practices and sell the stocks that he owned in these companies. The impact of the scam had many consequences, which included the loss of money to lakhs of families and the immediate crash of the stock market. The index fell from 4500 to 2500 representing a loss of Rs.1000 billion in market capitalisation. This rapid fall was the largest the stock market had ever seen. The 1992 scam raises many questions involving bank officials responsible for being in collusion with Mehta. An interview with Montek Singh Ahluwalia (Secretary, economic affairs at the Ministry of Finance) revealed that many top bank officials were involved.

### Stamp paper scam

In the early 90's, banks in India were not allowed to invest in the [Stock market|equity markets]. However, they were expected to post profits and to retain a certain ratio (threshold) of their assets in government fixed interest bonds. Mehta squeezed capital out of the banking system to address this requirement of banks and pumped this money into the share market. He promised the banks higher rates of interest, while asking them to transfer the money into his personal account, under the guise of buying securities for them from other banks. At that time, a bank had to go through a broker to buy securities and forward bonds from other banks. Mehta used this money temporarily in his account to buy shares, hike up demand of certain shares (of good established companies like ACC, Sterlite Industries, and Videocon) dramatically, sell them off, pass on a part of the proceeds to the bank and keep the rest for himself. This resulted in stocks like ACC, which was trading in 1991 for ₹200/share, catapult to nearly ₹9,000 in just 3 months.

### Bank receipt scam

Another instrument used in a big way was the bank receipt (BR). In a ready forward deal, securities were not moved back and forth in actuality. Instead, the borrower, i.e. the seller of securities, gave the buyer of the securities a BR. The BR serves as a receipt from the selling bank, and also promises that the buyer will receive the securities they have paid for at the end of the term.

Having figured this out, Mehta needed banks, which could issue fake BRs, or BRs not backed by any government securities.

Once these fake BRs were issued, they were passed on to other banks and the banks in turn gave money to Mehta, plainly assuming that they were lending against government securities when this was not really the case. He took the price of ACC from ₹200 to ₹9,000. That was an increase of 4,400%, which was tied into the overheating of the stock market. Since he had to book profits in the end, the day he sold was the day when the markets crashed.

### Ready forward deal scam

The Ready Forward Deal scam is a way in which there exists a broker between two banks. When one bank want to sell securities, it approaches a broker. This broker goes to another bank and tries to sell the securities and vice versa for buying. Since Mehta was a very renowned broker, he got cheques issued in his name instead of the bank. When the bank that wanted the money for the securities, he approached another bank and repeated the same process while using Bank Money in the stock market. Mehta used the ready forward deal and applied it to the Bank Receipts system of the Indian financial systems. This system was the most flawed system as the Janakiraman Committee restructured the entire Bank Receipts system after the 1992 scam.

The bank receipt scam is a ready forward deal of securities. The Bank Receipt confirms the sale of securities. The receipt acts as a receipt for the money received by the selling bank. Through the bank receipt, the bank promises securities. The seller holds the securities in trust for the buyer according to principal.

Mehta used forged BR's to gain unsecured loans, and used several small banks to issue BRs on demand. Since these banks were small, Mehta held on to the receipts as long as he wanted. The cheques in favour of both the banks were credited into the brokers' accounts which was the account of Mehta. As a result, banks made heavy investments into BOK and MCB as they showed positive signs of growth. Using the BR scam, Mehta took the price of ACC from ₹200 to ₹9000 in a short span of time. This 4400% percent increase was seen in several other stocks and as he sold the stocks, the market crashed.

This went on as long as the stock prices kept going up, and no one had a clue about Mehta's operations. Once the scam was exposed, though, a lot of banks were left holding BRs which did not have any value – the banking system had been swindled of a whopping ₹4,000 crore (equivalent to ₹**Formatting error: invalid input when rounding** or US$**Formatting error: invalid input when rounding** in 2018). He knew that he would be accused if people came to know about his involvement in issuing cheques to Mehta. Subsequently, it transpired that Citibank, brokers like Pallav Sheth and Ajay Kayan, industrialists like Aditya Birla, Hemendra Kothari, a number of politicians, and the RBI Governor S.Venkitaramanan all had played a role in allowing or facilitating Mehta's rigging of the share market.

### Realization of scam and market crash

The scam first became apparent in late April 1992, when it became clear that Mehta was a disproportionately large investor in government securities. At the time, Mehta was doing more than a third of the total securities business in India. When the public realized that Mehta's investments were illegitimate and that his stocks were likely worthless, it set off a selling frenzy of Mehta's stocks. The banks that had loaned money to Mehta were suddenly holding hundreds of millions in unsecured loans. The combination of the selling frenzy and the fact that numerous banks been defrauded crashed the Indian stock market, with prices dropping 40% immediately. Stocks eventually dropped 72%, and a bear market lasted for about 2 years.

This table illustrates the extent of money certain banks lost.

 State Bank Of Saurashtra
 SBI Capital Markets Ltd(SBI Caps)
 Standard Chartered Bank
 Total

## Exposure, trial and conviction

Exploiting several loopholes in the banking system, Mehta and his associates siphoned off funds from inter-bank transactions and bought shares at a premium across many segments, triggering a rise in the BSE SENSEX. When the scheme was exposed, banks started demanding their money back, causing the collapse. He was later charged with 72 criminal offences, and more than 600 civil action suits were filed against him.

He was arrested and banished from the stock market with investors holding him responsible for causing losses to various entities. Mehta and his brothers were arrested by the CBI on 9 November 1992 for allegedly misappropriating more than 2.8 million shares of about 90 companies through forged share transfer forms. The total value of the shares misappropriation was placed at ₹250 crore (equivalent to ₹15 billion or US$220 million in 2019).

Mehta made a brief comeback as a stock market guru, giving tips on his own website as well as a weekly newspaper column. However, in September 1999, Bombay High Court convicted and sentenced him to five years rigorous imprisonment and a fine of ₹25,000 (US$350). On 14 January 2003, The Supreme Court of India confirmed High Court's judgement in a 2–1 decision. While Justice B.N. Agrawal and Justice Arijit Pasayat upheld his conviction, Justice M.B. Shah voted to acquit him.

### Allegations of payment of bribe to India's prime minister

Mehta raised a furor on announcing that he had paid ₹10 million to the then Congress President and Prime Minister, P.V. Narasimha Rao, as a donation to the party, for getting him off the scandal case.

## Impacts

The immediate impact of the scam was a fall in share prices and the biggest plunge in the index the market had ever seen. The scam caused the breakdown of the securities control system, both within the commercial banks and the fundamental system of the RBI. The scam resulted in the withdrawal of about ₹35 billion from the ₹2,500 billion market, causing a collapse of many stock market shares. This was due to the fact that the Bombay Stock Exchange resorted to tampering within the records in the trading system. The majority Indian stock market is based on emotions rather than quantitative analysis and as the scam came to light, many investors withdrew their capital from the market. This caused a demand and supply collapse of the prices and quantity which caused the entire system to be affected due to the 1992 scam. As the scam came to light, many banks were impacted as the news of the scam spread through the financial markets around the world. Several foreign banks like Standard Chartered and ANZ Grindlays, were implicated in the scam. Standard chartered was accused of the bank receipt scam as they issued receipts to Mehta while ANZ Grindlays was accused of pumping money into Mehta's personal account. Therefore, the private sector was the main participant in the market for the Bank Receipts Scam. The government realized that the fundamental problem with the financial structure of the stock markets was the lack of computerized systems which impacted the whole stock market.

The 1992 scam caused an investigation through which many officials were implicated in fraudulent charges. The five main accused officials were related to the Financial Fairgrowth Services Limited (FFSL) and Andhra Bank Financial Services Ltd (ABFSL). The chairman of Vijaya Bank committed suicide following the outbreak of news about the bank receipt scam. The scam also led to the resignation of P. Chidambaram who was accused of owning shell companies related to Mehta. Mehta was convicted by the Bombay High Court and the Supreme Court of India for his part in this financial scandal valued at ₹49.99 billion (USD $740 million). There were many arrests that were made which exposed several bank officials and led to complete breakdown on many banking systems

### Subsequent reforms

The security system of India took a rapid reform in its fundamental structure post the 1992 scam. The first major structural change was the formation of the National Stock Exchange of India(NSE). The first major reform in the financial sector of India was the formation of CII Code for Desirable Corporate Governance developed by Rahul Bajaj. The formation of this code paved way for two major committees headed by Kumar Mangalam Birla and N. R. Narayana Murthy which was overlooked by the Securities and Exchange Board of India. These committees were formed to look after corporate governance as the 1992 scam was based on the principles of corporate governance. Post 1992, a new regulatory board known as the Securities and Exchange Board of India was formed to monitor the National Stock Exchange and the National Securities Depository. There were structural changes in the equity market. The government introduced ten acts of parliament and one constitutional amendment based upon the principles of economic reform and legislative change for the equity market. The NSE introduced online trading in 1994 which changed the dynamics of stock buying and selling. The capital market now opened up nationally as opposed to being confined in Mumbai. The exchange system started functioning based on satellite communications that abolished geographical barriers.

### Changes in the financial structure of India

The 1992 scam saw the Indian Market collapse completely as the stock prices dropped by almost 40% wiping out market value by ₹1,000 billion. The Indian Financial system saw a complete restructuring of the fundamental systems. The first structural change that was enforced was the payments for purchase of investments for which Subsidiary General Ledgers and Bank Receipts were recorded so as to prevent any defaulted paperwork. A new committee was formed within the financial systems to overlook the Securities and Exchange Board of India through the decision of the Janakiraman Committee. The committee ordered that the long standing practice of banks entering in to "ready forward" and "double ready forward" deals with other banks be restricted under the guidelines of the Reserve Bank of India(RBI) to only government securities. The committee made changes to the idea of custodian banks by making all banks custodians rather than principals in transactions. The banks were ordered to have a separate audit system for portfolio management of the banks whose adequacy was monitored by the RBI. The RBI was given more power and their scope in the financial markets increased. The entire stock system restructured to prevent any other scams.

## In popular culture

The scam was dramatized in 2020 web series *Scam 1992*, created by Hansal Mehta, with Pratik Gandhi and Shreya Dhanwanthary playing the roles of Harshad Mehta and Sucheta Dalal respectively. The series was adapted from journalist Sucheta Dalal and Debashish Basu's 1992 book *The Scam: Who Won, who Lost, who Got Away*.