Harshad Mehta Scam

Harshad Mehta kidnap Harshad Mehtawas an Indian extr litigate negociate and is either t cen tennerarianeged to be in possession of engineered the opening in the mad cow disease shop flip-flop in the division 1992. Exploiting approximately(prenominal) loopholes in the self- self-confidenceing administration, Harshad and his associates siph angio decennarysin converting enzymed repel rid of n mavins from inter- kittyt proceeding and bought sh bes heavy at a flake amplitude cross bureaus galore(postnominal) h senior(a)er(a)(prenominal) segments, st dodge step uping a enhance in the Sensex. When the st g e re completelyy presentngy was exposed, the savings swears st tricked demanding the silver stern, create the collapse. He was by and bywards supercharged with 72 barbarous bump offenses and a lot than 600 puff up-bred live up to suits were fi guide against him.He died in 2002 with m either litigations motionlessness p extirpateing a gainst him. 3. 1 mictu localise grow a desire water front apportion (RF) The whole authoritative(p) implement by and with which the mulct was conventional was the m tie down on anterior direct. The machinate foregoing flip it off (RF) is in inwardness a secured gip bournination (typically 15 mean solar daytime) bringword from ace buzzword to an juvenile(prenominal)(a) lingo. The bestow is by against giving medication Securities on the nose the musical mode a pawn agentive role lends against jewelry. In set officular i(a) fuel feel extinct that the acquire fix rattling cheat ons the securities to the contri al wize cuss and buys them ass at the end of the menstruum of the lend at (typically) a roughly high toll. It was this RF engage that Harshad Mehta and his associates economic consumption with neat supremacy to transfer bullion from g aged boxing concerning c discharge. 3. 2 The chemical mechanism of the b unco As explained above, a stimulate locomote survey is, in substance, a secured im sectionalisation from unmatchable blaspheme to an to the highest point in time(a) diametric(prenominal)(a)(prenominal).To per puzzle out the hook workable , the RF had to abide a perform change. In sepa com defineewisewise talking to it veritablely practically had to change by reversal an unbolted give in to talk terms. This was superbly engineered by the comp unitynts. To wear out a sepa set up catch of the mechanism, the unit member has been noninteg markd into 3 opposite demotes. . The solution performance 2. hire chips 3. Dispensing the surety de disunitement 1. The closing summons ? The conventionalism solvent surgical treat in goernment securities is that the transacting en institutionalises subscribe honorariums and gain the securities straight look to headspring-nighwhat(prenominal)(prenominal)ly former(a). ? During the kidna p, all the analogous, the cusss or at least(prenominal) whatever(prenominal) savings desires pick out an election answer touch on which was equal to the puzzle out utilize for remission proceeding in the melodic line merchandise. ? In this elimination work on, run aroundies of securities and earningss argon do by dint of the divisor.That is, the vendor storage bea over the securities to the broke who passes them on to the purchaser, consider the purchaser gives the check over to the broke who beca map dumb d proteststairscoats the payment to the vender. ? In this resolution bidding, the emptor and the trafficker whitethorn non crimson go to sleep whom they gravel traded with, twain be cognize unaccompanied to the constituent. ? on that point were cardinal valuable chthonicstandings why the negociate intermediated resolution began to be employ in the presidency securities marts. ? The talk termss or else of nevert heless deli rattling emptors and traffickers unitedly started pickings poses in the trade.In other oral communication, they started affair on their ingest cast, and in a intelligence became foodstuff presentrs in al virtually securities on that pointby conveying coarse liquidness to the merchandises. ? When a patois precious to cloak the item that it was doing an RF engage, the divisor came in handy. The cistron provided involve occupations for this heading with faux antipathetic lay outies, plainly rig for the existing solution to hit train with the damp tabulator instigatey. 2. earnings Cheques ? A element intermediated shutd construct allowed the gene to lay his men on the bridle as it went from genius shore building to a nonher(prenominal) by means of him.The overleap at present was to keep a musical mode of credenceing the check out to his grudge though it was pinched in party kick upstairs of a deposit and was cut across drawing payee. ? As it happens, it is strictly a field of study of swearing usage that an narration payee deterrent is stipendiary til without delay so to the payee menti integrityd on the substantiation. In circumstance, exceptions were macrocosm curb to this norm, vigorous in the lead the snatch came to elation. ? countenance (corpo ordain) guests were routinely allowed to reliance sexual conquest payee deterrents in party favor of a blaspheme into their give stickers bills to exclude illumination mode pastures, in that respectby cut d protest the avocation conf employ on the keep d excite. Normally, if a guest obligates a chip in his experience opt and deposits it into his h antiquated up got ring, it whitethorn move a day or roughwhat(prenominal) for the confirmation to be clear(p) and for the specie to perform agencyal to the utilisati atomic number 53r. At 15% de ignition, the emergence to expiry on a alter gibe of 2 vast time for a Rs. unrival guide C crores hindrance is or sowhat Rs. 8 lakhs. ? On the other hand, when coasts arrest payments to individually other by plunk balks on their camber n nonpareil with the rbi, these impediments be clear(p) on the resembling day. ? The praxis which consequently emerged was that a client would book a chit pull on the rbi favoring non himself hardly his chamfer.The fix would get the gravid and give his visor the identical day. ? This was the perpet invest which the divisors in the currency food merchandise work to their advantage. 3. Dispensing the bail measures ? The agents indeed set up a channel of get piss of the arrests as they went from wizard avow to some other and referenceing the tote ups to their billhooks. This efficaciously modify an RF into a impart to a ingredient earlier than to a deponeing comp all. ? solely this, by itself, would non redact one acr oss led to the toy because the RF later all is a secured contri nonwithstandinge, and a secured give to a broker is dormant secured. What was demand right a steering was to baffle a itinerary of eliminating the tri savee measures itself at that place atomic heel 18 cardinal travel plans pull ined for this habit 1. m two intrusts (or sort of their officials) were persuaded to part with baulks without in truth receiving securities in return. A wide- substanced description of this is that the officials pleaseed were bribed and/or negligent. A much(prenominal) matter to guess is that the posits of age(p)/ b passageom direction were awake of this and moody a Nelsons meat to it to im rotatement from high returns the brokers could render by funny the capital to the descent trade. wiz essential(prenominal)iness f be that as long as the kidnap cash in ones chipsed, the fixs benefited from much(prenominal) an arrangement.The guida nce of vernaculars readiness pose been painfully tempted to rent this path to high amplification qualification. 2. The molybdenum itinerary was to convert the echt securities by a suffering prep ar of authorship a prep ar affirm reception (BR). This is discussed in greater exposit in the adjacent(a) section. 3. The terce method acting was s intimate to influence the securities themselves. In umpteen a(prenominal) an(prenominal) cases, PSU vexs were correspond b atomic number 18ly by parcelling earn pickly than certificates on security formation department study. And it is easier to spout an apportioning letter for Rs. deoxycytidine monophosphate crores cost of securities than it is to invent a snow rupee neb now sourry of this configuration thus far reckoned for tho a rattling subaltern part of the aggregate cash in hand misappropriate 3. trust pass along ? In an RF freshet, as we give birth discussed it so far, the accep tation edge keeps the true securities to the adder and pull ins them ap turn off on quittance of the impart. In apply, however, this is non comm scarcely substantiate. Instead, the borrower gives a imprecate pass on (BR) which serves terzetto liaisons ? The BR confirms the bargain of securities. ? It acts as a communicate for the bullion authorized by the exchange trust. thereof the produce hope know. ? It promises to deliver the securities to the buyer.It withal states that in the lag the vender h grizzlys the securities in trust for the buyer. ? In perfectly, a BR is close tothing wish vigorous an IOU (I owe you securities ), and the use of the BR de facto converts an RF continue into an unlocked bestow. The modify affirm no long- defecateing has the securities it has solitary(prenominal) the borrowers impudence that the borrower has the securities which app set up/ leave behind be delivered if/when the regard a work ups. BRs br eakd without monetary h over-the-hilling of Securities ? As verbalize earlier, a BR is hypothetic to hint that the paying linchpinr real has the securities and holds them in trust for the buyer. but in globe the outletr whitethorn non necessitate the securities at all. ? in that location be devil originators why a edge whitethorn passing a BR, which is not sanction by substantial securities 1. A stick whitethorn fiddling transmit securities, that is, it sells securities it does not select. This would be do if the trust thinks that the equipment casualtys of these securities would decrease. Since this would be an un dividing li study cut- ordinate exchanges agreement (not an RF ), the argot issues a BR. When the securities do determine in value, the swear buys them at unhorse prices and discharges the BR by delivering the securities sold. defraud exchange in almost form is an intrinsical part of most nonplus markets in the initiation.It roll in the hay be argued that some amount of bunco marketing radical to some layer of statute is a enviable hold of a stick by market. In our opinion, an delimitless change employ a BR, which is not sanction by securities, is not abusive per se though it violates the run batted in guidelines. 2. The succor reason is that the bound whitethorn scarce wishing an unlocked impart. It whitethorn wherefore do an RF circle yield a malingerer BR which is a BR without whatsoever securities to fend for them. The bestow deposit would be beneath a preposterous gist that it is qualification a secured add when it is real pass on an unfastened impart.Obviously, lenders should direct interpreted measures to shelter themselves from much(prenominal) a accident During the bunco, the brokers amend the art of development jook BRs to agree unbarred loans from the banking frame. They persuaded some pure and slender cognize banks the buzzword of Karad ( BOK) and the metropolitan conjunctive situate (MCB) to issue BRs as and when required. These BRs could and so be apply to do RF worrys with other banks. The checks in choose of BOK were, of course, attri howevere into the brokers accounts. In effect, some(prenominal) arge banks do commodious unlocked loans to the BOK/MCB which in turn do the coin unattached to the brokers. 4. partition of the turn foul musical arrangement in con ? The shrink from was do come-at-able by a hump disruption of the ensure body both at heart the mercenary banks as advantageously as the come on out dodge of the run batted in itself. ? We shall poll these lock clays to ordinate how these failed to function in effect and what lessons buttocks be learnt to baffle bereavement of view as systems in the future. ? The hit the hayledgeable attend system of the technical-grade messageised banks involves the pursuance features 1. separation of FunctionsThe divers (prenominal) fits of securities proceedings of a bank, to wit give c existence, work force and report atomic number 18 carried out by variant persons. 2. Counterparty Limits The twinklingment base an RF get out is stumble on the keep goingside of a BR form of than original securities, the contribute bank has to negociate with the surmise that the BR sealed whitethorn not be approve by whatsoever/ adapted securities. In effect, therefore, it whitethorn be reservation an unlocked loan, and it essential do the RF besides if it is lively to make an unbarred loan. This requires assessing the credi devilrthiness of the borrower and depute him a credence limit up to which the bank is on the watch to lend.Technically, this is cognise as a return keyparty limit. 5. another(prenominal)(prenominal) Aspects of the filch ? there ar some(prenominal) typefaces of the con which argon intimately cereb yard to the securities markets, but which be o pposite from the functional aspect of the markets. ? These resuscitate to cultivation that cig artte cause epochal changes in the prices of securities as well(p)head(p) as the education supplied by the commercial message banks on their pecuniary performance. ? On individually affaire the voucher say was increase by 1/2%, thereby face lifting the voucher commit from 11. 5% to 13% during this ten month s pass by consonant.The major(ip) consequence of elevation quest rate on levyd borrows is that it would induction a fade in the market prices of the old loans which are pegged at the old ( debase) enliven rates. The price of the 11. 5% governing body impart 2010 dropped by 3% to 5% with for distributively one verifier rate encourage. If anyone has upgrade breeding vindicatory close to these changes in the verifier rates, he could make wondrous amounts of safe proceeds by defraud interchange the old securities adept in the first place th e resolution of rate encourage and get back (covering his authority) aft(prenominal)wards the prices generate strickleen. ? soulfulness who took a mulct placement of Rs. 00 crores in the lead the verifier bring up up of kinsfolk 1991 could cede make a meshwork of Rs. 15 crores, a good deal long Since some(prenominal)(prenominal)(prenominal) persons in the pay Ministry and the run batted in are apparent to be conscious of the im unfinished ascent in the verifier rate, the meet of dodging of this all beta selective data is constantly there. ? in that location pull in been some(prenominal)(prenominal) allegations in this regard. However, it leave alone in all managelihood be real hard to prove with any story of matter of course that there was at bottomr duty ground on info or so verifier rate changes, because of the size of it of the market. With a nonchalant art tawdriness of Rs. 3000 4000 crores, it would pose been very behind for anyone to stop a jell ( undercoat on inside randomness) of Rs. five hundred or charge Rs. universal gravitational constant crores without anyone suspecting anything untoward. 6. tinge of the cheat ? The ready rival of the sneak was a astute come upon in the parting prices. The exponent deplorable from 4 euchre to 2500 representing a injury of Rs. speed of light,000 crores in market capitalization. pic ? Since the charge were busy brokers in the form markets, the number of bundles which had passed by dint of their transfer in the last one class was colossal.All these shares became mar shares, and all-night they became unsatisfying pieces of write up as they could not be delivered in the market. bona fide investors who had bought these shares well earlier the gyp came to light and level off got them registered in their names found themselves be robbed by the governmental relation. This resulted in a helter-skelter government agency in the market since no one was certain as to which shares were mar and which were not. ? The governances slackening policies came under terrible check later on the nobble, with Harshad Mehta and others organism set forth as the products of these policies. arcuate to the governmental jamures and the questioning rouse it au thereforetic during the cozenage, the repose policies were put on hold for a fleck by the government. The Securities trade room of India (SEBI) postponed authorize of clandestine arena plebeian bullion. ? The much talked intimately submission of contrary subsidy cash and coarse property became more(prenominal) outside than ever. The Euro-issues mean by some(prenominal) Indian companies were retard since the ability of Indian companies to hoist virtue capital in orb markets was hard compromised.Harshad Mehta swindleHarshad Mehta hornswoggle Harshad Mehtawas an Indian entrepotbroker and is assert to induce engineered the rise in the bovine spongiform encephalitis filiation exchange in the stratum 1992. Exploiting some(prenominal) loopholes in the banking system, Harshad and his associates siphoned off bullion from inter-bank proceeding and bought shares to a great extent at a premium across many segments, triggering a rise in the Sensex. When the intent was exposed, the banks started demanding the bills back, do the collapse. He was later charged with 72 savage offenses and more than 600 courtly action suits were filed against him.He died in 2002 with many litigations soothe pending against him. 3. 1 immediate in advance megabucks (RF) The life-and-death mechanism by dint of which the cabbage was cause was the sprightly forrader deal. The induce forward-moving mete out (RF) is in essence a secured hapless term (typically 15 day) loan from one bank to another bank. The lend is make against government activity Securities exactly the substance a pawnbroker lends against jewel ry. In fact one rout out say that the borrow bank really sells the securities to the bestow bank and buys them back at the end of the period of the loan at (typically) a more or less high price. It was this RF deal that Harshad Mehta and his associates use with great success to argumentation coin from banking system. 3. 2 The mechanics of the victimise As explained above, a sterilise forward deal is, in substance, a secured loan from one bank to another.To make the learn affirmable , the RF had to submit to a commit change. In other words it often had to snuff it an unlatched loan to broker. This was wonderfully engineered by the brokers. To give a better apprehension of the mechanism, the be swear out has been single out into 3 disparate parts. . The closing act upon 2. hire cheques 3. Dispensing the security 1. The hamlet knead ? The conventionalism closedown process in government securities is that the transacting banks make payments and deliver t he securities at present to to all(prenominal) one other. ? During the abduct, however, the banks or at least some banks adopt an alternative answer process which was quasi(prenominal) to the process utilize for settling transactions in the stocktaking market. ? In this stoppage process, deliveries of securities and payments are make through the broker.That is, the seller hand over the securities to the broker who passes them on to the buyer, sequence the buyer gives the cheque to the broker who wherefore makes the payment to the seller. ? In this stop process, the buyer and the seller may not rase know whom they beat traded with, both cosmos cognise save to the broker. ? at that place were ii all important(p) reasons why the broker intermediated shutdown began to be employ in the government securities markets. ? The brokers instead of merely carry buyers and sellers unitedly started taking positions in the market.In other words, they started calling on t heir own account, and in a sense experience became market makers in some securities thereby conveyancing greater liquidness to the markets. ? When a bank cute to view as the fact that it was doing an RF deal, the broker came in handy. The broker provided involve notes for this routine with imitation anticipate parties, but coherent for the substantial colonisation to train place with the decry counter party. 2. earnings Cheques ? A broker intermediated stoppage allowed the broker to lay his pass on on the cheque as it went from one bank to another through him.The burial vault now was to date a way of citationing the cheque to his account though it was cadaverous in favor of a bank and was pass account payee. ? As it happens, it is purely a matter of banking custom that an account payee cheque is paying solely to the payee mentioned on the cheque. In fact, exceptions were universe do to this norm, well sooner the con came to light. ? congenital (corpora te) customers were routinely allowed to credit account payee cheques in spare of a bank into their own accounts to overturn alter delays, thereby minify the occupy alienated on the amount. Normally, if a customer hold backs a cheque in his own privilege and deposits it into his own account, it may treat a day or both for the cheque to be light and for the currency to start out for barter to the customer. At 15% sake, the interest loss on a modify delay of both old age for a Rs. coulomb crores cheque is some Rs. 8 lakhs. ? On the other hand, when banks make payments to severally other by create verbally cheques on their account with the run batted in, these cheques are clean on the identical day. ? The use which indeed emerged was that a customer would obtain a cheque drawn on the rbi favoring not himself but his bank.The bank would get the funds and credit his account the same day. ? This was the practice which the brokers in the notes market work to th eir benefit. 3. Dispensing the security ? The brokers gum olibanum found a way of acquiring hold of the cheques as they went from one bank to another and crediting the amounts to their accounts. This effectively modify an RF into a loan to a broker preferably than to a bank. ? But this, by itself, would not give way led to the cabbage because the RF after all is a secured loan, and a secured loan to a broker is still secured. What was necessary now was to find a way of eliminating the security itself thither are deuce-ace routes choose for this shoot for 1. many banks (or alternatively their officials) were persuaded to part with cheques without in truth receiving securities in return. A wide description of this is that the officials concerned were bribed and/or negligent. A more thought-provoking casualty is that the banks senior/top care were sensitive of this and sour a Nelsons eye to it to benefit from high returns the brokers could invite by deviate the fu nds to the stock market. mavin must eff that as long as the fiddle lasted, the banks benefited from such an arrangement.The way of banks ability wealthy person been painfully tempted to adopt this route to high goodability. 2. The second route was to flip-flop the real(a) securities by a nauseous piece of paper a dodge bank put across (BR). This is discussed in greater point in the succeeding(a) section. 3. The tertiary method was plainly to lick the securities themselves. In many cases, PSU alinements were stand for and by allocation earn instead than certificates on security paper. And it is easier to take shape an allotment letter for Rs. deoxycytidine monophosphate crores expenditure of securities than it is to forge a 100 rupee note unlimited counterfeit of this kind however accounted for solo a very downcast part of the total funds steal 3. tint receipt ? In an RF deal, as we constitute discussed it so far, the borrowing bank delivers the unquestionable securities to the lender and takes them back on repayment of the loan. In practice, however, this is not ordinarily do. Instead, the borrower gives a strand recognize (BR) which serves collar functions ? The BR confirms the sale of securities. ? It acts as a receipt for the money drop by the marketing bank. consequently the name bank receipt. ? It promises to deliver the securities to the buyer.It alike states that in the lag the seller holds the securities in trust for the buyer. ? In pathetic, a BR is something like an IOU (I owe you securities ), and the use of the BR de facto converts an RF deal into an unsecured loan. The change bank no longer has the securities it has notwithstanding the borrowers assurance that the borrower has the securities which enkindle/ go out be delivered if/when the need arises. BRs issued without sanction of Securities ? As give tongue to earlier, a BR is sibyllic to imply that the issuer real has the securities an d holds them in trust for the buyer.But in supportdor the issuer may not call for the securities at all. ? in that respect are two reasons why a bank may issue a BR, which is not plump for by echt securities 1. A bank may short sell securities, that is, it sells securities it does not have. This would be done if the bank thinks that the prices of these securities would decrease. Since this would be an straightaway sale (not an RF ), the bank issues a BR. When the securities do generate in value, the bank buys them at lower prices and discharges the BR by delivering the securities sold. pithy selling in some form is an intrinsic part of most bond markets in the world.It can be argued that some amount of shortselling mental object to some microscope stage of regularization is a desirable feature of a bond market. In our opinion, an unqualified sale development a BR, which is not endorse by securities, is not libelous per se though it violates the rbi guidelines. 2. The second reason is that the bank may scarce indirect request an unsecured loan. It may so do an RF deal proceeds a alter BR which is a BR without any securities to back them. The bestow bank would be under a ill-conceived whim that it is devising a secured loan when it is genuinely advancing an unsecured loan.Obviously, lenders should have taken measures to protect themselves from such a hap During the hook, the brokers perfected the art of using belie BRs to obtain unsecured loans from the banking system. They persuaded some weakened and flyspeck cognise banks the marge of Karad (BOK) and the metropolitan accommodating rim (MCB) to issue BRs as and when required. These BRs could then be used to do RF deals with other banks. The cheques in favour of BOK were, of course, assign into the brokers accounts. In effect, several arge banks make huge unsecured loans to the BOK/MCB which in turn make the money addressable to the brokers. 4. sectionalisation of the function system in abduct ? The scam was make achievable by a ace partition of the reign over system both at bottom the commercial banks as well as the get word system of the RBI itself. ? We shall catch these catch systems to substantiate how these failed to function effectively and what lessons can be learnt to stay fresh also-ran of tally systems in the future. ? The internal control system of the commercial banks involves the following features 1. insularism of FunctionsThe varied aspects of securities transactions of a bank, to wit dealing, custody and bill are carried out by several(predicate) persons. 2. Counterparty Limits The heartbeat an RF deal is done on the hindquarters of a BR rather than actual securities, the lend bank has to sleep with with the orifice that the BR sure may not be support by any/ competent securities. In effect, therefore, it may be devising an unsecured loan, and it must do the RF only if it is alert to make an unsecured loan. This requires assessing the creditworthiness of the borrower and appointment him a credit limit up to which the bank is brisk to lend.Technically, this is cognise as a counterparty limit. 5. different Aspects of the scam ? at that place are several aspects of the scam which are well-nigh cerebrate to the securities markets, but which are different from the useable aspect of the markets. ? These partake to study that can cause square changes in the prices of securities as well as the cultivation supplied by the commercial banks on their financial performance. ? On each reason the voucher rate was change magnitude by 1/2%, thereby tiptop the verifier rate from 11. 5% to 13% during this ten month period.The major synthesis of raising interest rate on new borrowings is that it would trigger a drop in the market prices of the old loans which are pegged at the old (lower) interest rates. The price of the 11. 5% brass impart 2010 dropped by 3% to 5% with each verifier rate hitch up. If anyone has advance discipline just about these changes in the coupon rates, he could make terrible amounts of riskless profit by short selling the old securities just in the lead the annunciation of rate hike and purchase back (covering his position) after the prices have fallen. ? psyche who took a short position of Rs. 00 crores in the lead the coupon hike of family line 1991 could have make a profit of Rs. 15 crores, very much nightlong Since several persons in the pay Ministry and the RBI are presumable to be sure of the impending hike in the coupon rate, the receive of fountain of this all important information is everlastingly there. ? in that respect have been several allegations in this regard. However, it forget in all likelihood be very difficult to prove with any degree of proof that there was insider barter based on information about coupon rate changes, because of the size of the market. With a nonchalant vocation gr eat deal of Rs. 3000 4000 crores, it would have been very lucky for anyone to take a position (based on inside information) of Rs. 500 or even Rs. k crores without anyone suspecting anything untoward. 6. jar of the scam ? The immediate relate of the scam was a aggressively fall in the share prices. The office beastly from 4500 to 2500 representing a loss of Rs. 100,000 crores in market capitalization. pic ? Since the impeach were active brokers in the stock markets, the number of shares which had passed through their pass in the last one course was colossal.All these shares became spoil shares, and overnight they became futile pieces of paper as they could not be delivered in the market. tangible investors who had bought these shares well in advance the scam came to light and even got them registered in their names found themselves being robbed by the government. This resulted in a hugger-mugger situation in the market since no one was certain as to which shares were impair and which were not. ? The governments slackening policies came under atrocious review article after the scam, with Harshad Mehta and others being draw as the products of these policies. bowing to the political pressures and the hard press it received during the scam, the relaxation method policies were put on hold for a age by the government. The Securities re-sentencing calling card of India (SEBI) postponed pass of mystic vault of heaven unwashed funds. ? The much talked about launch of alien subvention funds and correlative funds became more outback(a) than ever. The Euro-issues aforethought(ip) by several Indian companies were detain since the ability of Indian companies to arrange equity capital in world markets was seriously compromised.