Harshad Mehta scam in 1992 ushered regulatory regime in Indian capital market

India’s liberalisation era initiated in 1991 faced an immediate backlash in 1992 with a stock market scam that rocked the capital market of the then-emerging economy, which was reforming itself from the license raj.

Though termed as a stock market scam, this estimated Rs 5,000 crore scam involved bogus debt securities issued by Bank of Karad and Metropolitan Bank in connivance with the poster boy of the scam – Harshad Mehta.

Mobilising a huge sum by dealing in government securities issued by the above-mentioned banks, Mehta popularly called big-bull then pumped that amount in select large-company stocks and some initial public offers in the stock market.

In the process, he fraudulently manipulated the market by creating fictitious demand and disturbed the market equilibrium with an unprecedented rally.

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Makarand Joshi

Partner|MMJC and Associates

The scam went unnoticed for a period of four long years from 1988 to 1992 primarily because the Indian capital market was trading in physical shares and not in an electronic or Demat mode and there was no active regulator for the securities market.

The rip-off effects of the scam led to the emergence of a strong regulator, Securities, and Exchange Board of India (SEBI) (which was established in I988) being empowered by the government, according to statutory powers with the passing of SEBI Act 1992.

SEBI undertook a series of initiative to regulate listed and unlisted companies, initial public offerings, fraudulent trading activities, collective investment schemes followed by establishment of financial institutions promoted National Stock Exchange in I993 that commenced screen-based trading for equity and debt market segment followed by the Depositories Act 1996.

All these initiatives were good but not good enough to deter fraudulent motives of the white-collar scammers. Unfortunately, scams continue to galore.

In 1998, the market saw the Ketan Parekh scam of circular trading of securities and controlling prices followed by the Satyam scam of 2009 involving falsification of books of accounts and further to GDR/IPO related scam in 2010-11 of bogus investors and kick-backs to operators and so on.

In 2012, Sahara scam of manipulative investment scheme followed by Sharepro in 2016 which was a registrar and transfer agent that manipulated the physical holding of inactive folios.

All the lacuna that led to these scams has been addressed via various policy and regulatory interventions including KYC of investors, mandatory push for demat trading, monitoring hot and bad money in the market, suspending in-active companies, strict action on falsification of books of accounts, and closing down manipulative investment schemes.

It had also initiated measures to curb falsification of books of accounts like – disclosure of quarterly results, strict punitive actions against auditors (banning of PWC as an auditor), freezing all bank and demat accounts of the accused, strengthening of whistleblower mechanism, informant mechanism among several others.

Moreover, in the past 10 years, SEBI had closed 650 collective investment schemes and at times have either debarred or have forced the scheme owners to repay the money. While the wrongdoers have not been spared, but the scammers continue to innovate with novel methods and surface with new frauds.

Having said that, SEBI has done a lot in terms of systems and processes from verifying genuine companies to curb bogus transactions by giving adequate time to the stakeholders to fall in the line of compliance.

While the Depositories system came into existence in 1996, mandatory trading in demat happened in 2019 or so almost after 23 years)!!  Although Prohibition of Insider Trading was regulated since 1992, effective enforcement at the mass level started only in 2018-19.

In the year 2020-21, so far 36 cases have been penalised under insider trading which is the largest as compared to any of the previous years. Further, there are fears that COVID 19 and liquidity issues can give rise to the falsification of accounts.

Given the context, will keep my fingers crossed to see whether SEBI, which has more powers than the US capital market regulator SEC except for sending the accused to jail, is able to pre-empt probable frauds and curb those going forward or would it keep plugging gaps after each scam!

Read our entire coverage on Harshad Mehta here

(Makarand Joshi, Partner at MMJC and Associates LLP)

(The author is a practising company secretary and runs a corporate compliance firm in Mumbai)

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