harshad mehta

In India’s financial history, few names evoke as much intrigue, controversy, and fascination as Harshad Mehta. Known as the “Big Bull” of the Indian stock market, Harshad Mehta’s meteoric rise and subsequent fall represent a watershed moment in India’s financial landscape. The Harshad Mehta Scam of 1992 not only exposed the vulnerabilities in the Indian financial system but also triggered a wave of reforms and regulatory changes.

The Big Bull’s Rise

harshad mehta

Harshad Mehta, a stockbroker based in Mumbai, was not an ordinary player in the stock market. He exploited a fundamental weakness in the Indian banking system and the stock market’s regulatory framework. The primary tool in his arsenal was the ready-forward (RF) mechanism, a method of short-term financing involving the borrowing and lending of securities.

He took advantage of the fact that banks had significant funds parked in the form of government securities. These securities were meant to be held as collateral, so the banks were often willing to lend against them. Mehta capitalized on this by borrowing substantial sums of money from multiple banks, using these government securities as collateral.

With these funds in hand, he embarked on a buying spree, primarily in the shares of selected companies. His purchases were so substantial that they single-handedly influenced stock prices, leading to a self-fulfilling prophecy.

His massive purchases of these stocks caused their prices to soar, leading to a self-fulfilling prophecy. As the prices rose, other investors were drawn to these stocks, leading to even higher prices.

Creating Artificial Demand

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Mehta’s influence over stock prices extended beyond simple purchases. He employed a technique known as “circular trading.” In this method, he would buy shares and simultaneously sell them to another broker, often one of his associates. The understanding was that these shares would be repurchased at a slightly higher price, creating an artificial demand for the stock. This cycle would repeat, with Mehta and his associates profiting at each turn.

The technique of circular trading not only inflated stock prices but also contributed to the illusion of genuine demand in these stocks, attracting more investors who were unaware of the manipulative trading practices.

The Banking Connection

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The core of Mehta’s scheme revolved around his ability to secure vast amounts of money from the banking sector. He used fake bank receipts, popularly referred to as “BRs” or “Bank Receipts,” as collateral to obtain loans from various banks. These fake BRs falsely represented government securities held in the banks’ custodial accounts. Mehta used these fictitious BRs as a smokescreen to finance his stock purchases.

What was particularly audacious was that the banks failed to cross-verify these BRs with the Reserve Bank of India (RBI) due to the belief that government securities held in custody were secure. This allowed Mehta to obtain loans on an unprecedented scale, further fueling his stock market manipulations.

The Market Manipulation

harshad mehta

Harshad Mehta’s manipulation of the stock market was not restricted to circular trading and BR fraud. He also engaged in a practice known as “pooling.” In this scheme, he formed groups of individuals who would collectively invest in particular stocks. By doing so, he effectively controlled a significant chunk of shares in these companies, giving him even more influence over their stock prices.

This pooling allowed Mehta to orchestrate massive price movements in the stocks he targeted, often leading to artificially inflated valuations of these companies. This not only deceived investors but also led to severe market distortions.

The Scandal Unearthed

harshad mehta

The Harshad Mehta Scam came to light in 1992 when investigative journalists Sucheta Dalal and Debashis Basu published a series of reports in “The Times of India.” Their exposé meticulously outlined the irregular and fraudulent activities conducted by Mehta. It revealed the mechanisms of the scam, including the misuse of BRs and the manipulation of stock prices. The reports sent shockwaves through the financial community and prompted regulatory authorities to initiate investigations.

When the scam unraveled, the stock market plummeted, causing substantial losses for investors. Many individuals and institutional investors who had bought into the manipulated stocks suffered devastating financial consequences.

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In the aftermath of the scandal, Harshad Mehta faced multiple legal cases. He was arrested and spent time in custody. His trials continued for years, marked by numerous appeals and legal proceedings.

Reforms and Lessons

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The Harshad Mehta Scam prompted sweeping reforms in the Indian financial system. Regulatory authorities, including SEBI and the Reserve Bank of India (RBI), introduced a series of changes to prevent such scams in the future. These included improvements in banking regulations, stock market oversight, and the introduction of electronic trading and dematerialization of shares to enhance transparency and reduce fraud.

Conclusion

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The Harshad Mehta Scam is a testament to the power of financial manipulation and its potential consequences. Harshad Mehta’s intricate schemes left a trail of destruction but also catalyzed essential reforms that have made India’s financial system more resilient and transparent. The legacy of this scandal continues to influence financial regulation and oversight, underscoring the ongoing quest for financial integrity and stability in India.

The Harshad Mehta Scam left a lasting legacy, underscoring the importance of stringent financial regulations, vigilant oversight, and the need for a robust, transparent, and technologically advanced financial system in India. It serves as a constant reminder of the potential consequences of financial manipulation and the importance of regulatory vigilance in safeguarding the integrity of financial markets.

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