Who was Harshad Mehta?
Harshad Mehta was a common man who found the
loopholes in the law of securities in India in the late 1980s and early 1990s,
wherein, he used those loopholes and amassed a big fortune for himself. Harshad
Mehta first started as a jobber and then he became a registered stockbroker and
member with Bombay Stock Exchange.
How did Harshad do it?
Harshad Mehta knew the intricacies of the banking
system and tried to take full advantage of it. In the banking system, there are
certain concepts such as the reserve ratio and standard liquidate ratio. “The
banks as per the guidelines by RBI had to maintain certain reserve ratio which
was 25% at that time, and the reason as to why such reserve has to be
maintained by banks was that banks deals in both lending and deposits, now
banks mostly lends the money to needy at a higher interest and give depositor a
low interest, now RBI to protect depositors, asks banks that they should keep
at least 25% of the money with themselves so that depositors can easily take
their money back.”[1] Further, the banks had to maintain standard
liquidity ratio(hereinafter SLR), that means it was mandatory for banks to
invest in government securities. Government security is a way of the government
to raise capital to finance its expenditure.[2]
“Now, the RBI at that time relaxed the norms for
maintaining SLR from daily to weekly basis, that means that now banks who
earlier were required mandatorily to keep maintaining the SLR that was
38.5% at that time and send everyday updates to RBI to weekly maintenance.
Banks then started selling the government securities, to fulfil their short-term
capital requirement and other banks started purchasing the government security
to complete maintain their SLR.”[3]
There is also an important concept of Ready
Forward Deal (hereinafter RFD) that the banks were involved in. In
these types of deals, the bank who is in need of capital would sell their
government security to banks and these ready forward deals were done by the
intermediaries in the forms of brokers. Harshad Mehta found this concept of
ready forward deal as a chance to earn money since Harshad was the broker of
BSE, he used to participate in these ready forward deals, wherein he would take
the security from one bank and would take some time from bank to give them cash
for the security, then he would find a bank who needs any security, and will
take advance from them, and when the earlier bank from he took security demands
money, he will go to another bank, to take money for a promise to give security
in some days, and thus he kept the money of banks with himself and fooled banks
around.
But fooling banks was not that easy, what Harshad
did was that he started to make fake bank receipts(hereinafter BR). A BR is
used in RFD’s since actual security is not transferred, rather a BR was given
as a certificate of purchase of RFD by the selling bank and Harshad identified
certain banks, who were ready to make such fake BR’s and collaborated with them
and then he started giving fake BR’s top bank and would take money from banks.[4]
The banks who purchased the fake BR’s were also at fault since they never gave
the money in favour of another bank, but they transferred money to Harshad
Mehta, due to blind trust on him, which was not allowed as per rules and they
never checked the authenticity of BR that Mehta gave to them, and thus banks
were eventually responsible for such fraud.
What did the Big Bull do with the money taken from banks?
Harshad Mehta would take all the money from banks
and would invest them in the securities market and he used to inflate the
prices of stocks, and he would suggest that securities to his clients and thus,
this created a big name of Harshad Mehta in the stock exchange and that’s how
the big bull of stock market used to manipulate the shares and their prices
according to his will.
“Eventually, the scam was unearthed and identified
in 1992 and it amounted to be of 5000 crores at that time, of which the current
value rises between the range of 20,000 crores to 2,50,000 crore and around 600
cases were filed, and CBI filed 72 charge sheets against Harshad Mehta.”[5]
Corrective Measures after the Harshad Mehta Scam-
(1) Formation of SEBI:-
After the Harshad Mehta Scam, the stock market was
deeply disturbed and there was a need felt for a central body, that can
regulate the securities market, so the process to implement SEBI Act 1992 was
fastened and on 12th April 1992 SEBI was established
SEBI ACT 1992:-
a. The role of SEBI
under the act was defined as of protector of investor and regulator
of the market under section 11(1) of the act.
b. Under section 11(2)
SEBI had the role to regulate and register stock and sub-brokers,
which was added because of the Harshad Mehta Scam.
c. -The SEBI that we
know today in 2020 as a powerful regulator was not that much power when it was
established in 1992 and it did not have such wide powers like that of
Investigation under section 11C or to give penalty under section 15 under
the SEBI Act and with subsequent amendments, more power was given to SEBI.
(2) Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992
After the Harshad Mehta Scam, there was the
creation of a Special Court to fast track the cases which were specifically
dealing in securities, so that burden can be removed from courts.
Features of Special Court Trial of Offences Relating to Transactions in Securities) Act, 1992
a. As per section 3(2)
of the act, these special courts were made for cases exclusively dealing with
any kind of fraudulent activity that has been there related to securities.
b. As per the section 9
of the act, these special courts were given power as that of the court of
sessions and the procedure for following the proceedings has to be according to
the CrPC.
c. As per section 10 of
the act, if any person is unhappy with the decision of the Special Court, then
they can always go into the supreme court.
(3) The Securities Law(Amendment) Act 1995 (Now Repealed)
Another major change that was introduced, after the
Harshad Mehta scam, to protect the integrity of stock market was through
amendments done in the Securities Law Act which also brought changes in the
SEBI Act in 1995.
Key Amendments-
a. Through the
amendment in 1995, various powers were given to SEBI, which was necessary for
it, to effectively regulate the market.
b. Section 11(2)(ba)
was added wherein the regulating power of custodians of securities were given
to SEBI, along with the regulating power of depositories.
c. In section 11(2)
clause (la) was added, which gave power to SEBI, to ask any person, to give
SEBI information, which it may ask for any purpose.
d. Also, section 11(3)
was added that gave SEBI powers as that of the court of civil nature.
e. 11B was also added,
which gave SEBI power, in the cases to protect and safeguard investors, to
issue orders as it may deem fit.
f. Provisions for Power
of penalty that SEBI can impose under the act was first given to SEBI under
section 15A to 15H under the 1995 amendment.
Also, read- Does SEBI have the power to pass ex-parte orders?
[1]
Shreekant Vattiikuti, Accelerating towards Globalization: Indian Securities
Regulation since 1992, 23 N.C.J. INT'l L. & COM. REG. 105 (1997).
[2]
id
[3] Rinku, Prevention and control of corporate frauds: a socio-legal study of financial market in India, available at http://hdl.handle.net/10603/45803
[4]
id
[5] Sucheta
Dalal, Harshad Mehta's Conviction: How Not to Handle Financial Crimes, 34
E.W.P,2833(1999).
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