The Harshad Mehta Scam: India’s Biggest Stock Market Scam/Fraud

The Harshad Mehta Scam: India’s Biggest Stock Market Fraud

The Harshad Mehta scam is one of the most infamous financial frauds in India’s history, leaving a lasting impact on the country’s financial ecosystem. It’s a story of ambition, greed, and loopholes in the banking system that led to the manipulation of the stock market. This article dives deep into the scam, explaining how it unfolded, its consequences, and the lessons learned.

Who Was Harshad Mehta?

Harshad Mehta, often referred to as the “Big Bull” of the Indian stock market, was a stockbroker who rose to prominence in the late 1980s and early 1990s. Known for his flamboyant lifestyle and audacious trading strategies, Mehta became a household name as the stock market boomed under his influence. His ability to drive stock prices to unprecedented levels earned him admiration from many, but few knew the dubious means behind his success.

How Harshad Mehta Scammed the System

The Harshad Mehta scam, which came to light in 1992, was a result of systemic loopholes in the banking and financial systems. It was a well-orchestrated fraud that exploited trust, ignorance, and gaps in regulatory frameworks. Here is the detailed story of how he pulled off one of the largest financial scams in India’s history:

Step 1: Exploiting Bank Receipts (BRs)

Bank Receipts (BRs) were financial instruments used in interbank transactions as proof of purchase or sale of government securities. Mehta realized that BRs could be manipulated to raise huge sums of money without any real backing.

• Mehta approached smaller, less regulated banks and convinced them to issue fake BRs. These BRs indicated that the issuing bank had sold government securities to another bank, but in reality, no such securities existed.
• These banks issued BRs trusting that Mehta would honor the deal and complete the transactions.

Step 2: Diversion of Funds

Once Mehta obtained the fake BRs, he presented them to larger, reputable banks like the State Bank of India (SBI). These banks, believing the BRs to be legitimate, loaned massive sums of money to Mehta.

• For example, if a fake BR showed the purchase of government securities worth Rs. 100 crore, the larger bank would disburse that amount to Mehta.
• Mehta siphoned these funds directly into the stock market instead of purchasing government securities as intended.

Step 3: Stock Market Manipulation

With access to enormous amounts of cash, Mehta strategically invested in specific stocks to drive up their prices. His purchases created a demand surge, leading to skyrocketing stock prices.

• Mehta targeted blue-chip companies like ACC, Videocon, and Apollo Tyres. For instance, the price of ACC shares rose from Rs. 200 to nearly Rs. 9,000 within a short span.
• The artificial price hike created a frenzy in the market, attracting other investors who wanted to ride the wave of rising prices.

Step 4: Booking Profits

Once the stock prices reached their peak, Mehta began selling his holdings. The inflated prices ensured that his profits were massive. For instance:

• If Mehta had bought a stock at Rs. 200 per share and sold it at Rs. 9,000, his returns were astronomical.
• The proceeds from these sales were then used to repay some of the loans from banks, keeping the scam afloat temporarily.

Step 5: Creating a Ponzi Scheme

Mehta kept the cycle going by issuing new fake BRs to replace old ones. This created a Ponzi scheme within the banking system. New loans were used to repay older ones, ensuring that no one suspected foul play initially.

• Banks continued to trust Mehta because of his reputation and the substantial returns his investments seemed to generate.
• This allowed him to sustain his operations for several years, manipulating both the banking system and the stock market.

Step 6: The Breaking Point

The scam began to unravel when Mehta faced difficulties in managing the cash flow required to sustain the cycle. Several factors contributed to his downfall:

• Some banks started demanding repayment of their loans.
• Sucheta Dalal, a journalist for The Times of India, began investigating Mehta’s activities. She discovered that Mehta had illegally diverted Rs. 500 crore from SBI to manipulate the stock market.
• Her expose revealed the intricate web of fake BRs and misused funds, sparking nationwide outrage.

How the Scam Was Exposed

The scam came to light when journalist Sucheta Dalal exposed Mehta’s fraudulent activities. In her article, she detailed how Mehta had used the banking system to fund his stock market operations. This revelation triggered an investigation by regulatory authorities.

• The Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) launched probes into the banking and stock market irregularities.
• As investigations progressed, the magnitude of the scam became evident, leading to a collapse in investor confidence and a market crash.

Consequences of the Scam

1. Stock Market Crash: The Indian stock market witnessed a significant crash, wiping out investor wealth and causing panic among the public.
2. Legal Action Against Mehta: Harshad Mehta was arrested and charged with numerous offenses, including criminal breach of trust and forgery. He faced over 70 criminal cases and 600 civil suits.
3. Banking Reforms: The scam exposed weaknesses in the banking system, prompting reforms to strengthen regulations around BRs and interbank transactions.
4. Empowerment of SEBI: The scam led to the empowerment of SEBI, which was tasked with enforcing stricter controls on the stock market to prevent similar frauds.
5. Public Distrust: The scam eroded public trust in the stock market, making people wary of investing for years to come.

Harshad Mehta’s Downfall

Despite his attempts to defend himself, Mehta’s luxurious lifestyle—including his fleet of luxury cars and opulent home—became a symbol of his excesses. He was convicted in multiple cases but died of a heart attack in 2001 while still under trial.

Lessons Learned

The Harshad Mehta scam serves as a cautionary tale for investors, financial institutions, and regulators. Here are some key takeaways:

1. Due Diligence: Investors should conduct thorough research before investing, avoiding herd mentality driven by artificial price surges.
2. Regulatory Oversight: The importance of strong regulatory frameworks to monitor financial markets cannot be overstated.
3. Ethical Practices: The scam underscores the need for ethical practices in financial dealings to sustain long-term trust and stability.

Cultural Impact

The Harshad Mehta scam has been immortalized in popular culture, most notably through the web series “Scam 1992: The Harshad Mehta Story.” The show brought renewed attention to the scam, highlighting its complexities and Mehta’s enigmatic personality.

Conclusion

The Harshad Mehta scam was a watershed moment in India’s financial history. It exposed the vulnerabilities of the banking system and stock market, leading to sweeping reforms. While Mehta’s audacity and ingenuity are often marveled at, his story is a stark reminder of the consequences of unchecked greed and systemic loopholes. For today’s investors and regulators, the scam offers valuable lessons in vigilance, transparency, and ethical behavior.