Harshad Mehta Scam will reoccur

A web series on the infamous Harshad Mehta scam of early 1990s seems to have triggered a debate on the present state of the financial regulation and risk management practices in India. The key point of interest is whether a scam similar to Harshad Mehta scam could recur!

During late 1989–1992, a Mumbai (then Bombay) based stock broker Harshad Mehta used the inefficiency and lacunae in the banking and stock market systems to create massive pseudo credit. The credit so created was used to manipulate stocks prices, causing the first major bubble in Indian stock markets. This was the time when Indian economy was struggling with unprecedented balance of payment crisis, political uncertainty and higher energy prices due to war between Iraq and US (an ally of Kuwait) in the Persian gulf. Given the despondent economic situation huge short positions were built by traders in Indian equities. In the summer of 1991 the Congress government led by P. V. Narsimha Rao assumed office and unleashed a slew of radical reforms. Using this pretext, Harshad Mehta squeezed the short sellers by using the pseudo credit he could manage by defrauding the nationalized banks. The bubble finally burst in April 1992 when the modus operandi of Harshad Mehta was exposed.

The immediate fall out the bubble burst were (i) promulgation of the Securities and Exchange Board of India (SEBI) Ordinance 1992 to establish an autonomous regulator for regulation of securities market in India; and (ii) up-gradation and modernization of interbank settlement system of government securities. SEBI immediately issued a slew of rules and regulation to regulate the operations of stocks exchanges and market intermediaries. The first fully electronic stock exchange (OTC Exchange of India) modelled on NASDAQ of US was established in 1992. A National Stock Exchange (NSE) was established in 1994, as a nationwide fully electronic trading platform. Establishment of NSE eventually led to elimination of floor based trading and closure of 27 of the 28 regional stocks exchanges. India thus became the first country in the world to have 100% electronic trading in equities. Later Depositories Act was passed to enable establishment of depositories, dematerialization of securities and settlement of trades in electronic form.

The improvement in trading and settlement systems; tightening of margining norms; tightening of compliance procedures to protect the interests of investors etc. have been a continuous process since then. Each instance of fraud & manipulation, accident, unethical behavior has resulted in some improvement in the regulatory process in past 28 years.

However, the continuous strengthening and tightening of regulatory has not deterred the manipulators, fraudsters, and unethical promoters & intermediaries from indulging in fraud and malpractices. The IPO and plantation companies frauds of 1994–1996, dotcom fraud (Ketan Parekh) of 1999–2001, Sahara public Deposit scam, PACL Chit Fund Scam, LTCG Scam, numerous cases of insider trading and front running by mutual funds and corporate officials, act of impropriety by mutual funds (e.g., Franklin Templeton, Kotak MF, Birla MF) etc kept rocking the market intermittently. In fact it has been a 28yrs long episode of Tom (SEBI) and Jerry (Manipulators) where both are consistently trying to dodge each other.

Hence, there is no assurance that a Harshad Mehta like scam will not recur in Indian markets.

Writes for the love of Books, Movies, Music & Cricket. He opines that best investment ideas are often cracked by being on the road.