The Stock Market Scams that shook the Indian Investors

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If you received this message on your phone, you would have clicked on the link, filled out the form and emptied your bank account in about a minute. Congratulations on getting scammed!

"Risk hai toh Ishq hai"  – one of the most popular dialogues from The Scam 1992 that made the audience go awe with the plot and performance. However, along with the thrilling entertainment, it also showed the brutal truth of the Indian stock market. It is because of certain fraudulent people that the entire country and investors suffer. Let’s talk about the stock market scams in India that sent shockwaves down the spine of the entire nation.

Biggest Stock Market Frauds in India

When it comes to the stock market scams, the following top the list and will be remembered across ages in the history of the Indian stock market:

The Harshad Mehta Scam

This is the most popular and biggest stock market fraud in India that most Indians know, thanks to the web series and films made about it. This one is of the most popular rags to riches stories starting when Harshad Mehta first arrived in Mumbai with Rs. 40 in his pocket. 

After figuring out the stock market, he learned the tactics and incorporated his own company in 1984, i.e., ‘Growmore Research AND Assets Management LTD’. During that time, the banks were not allowed to invest in the stock markets and faced stiff competition from foreign players. 

Adding to that, they had to maintain the required Statutory Liquid Ratio (SLR). The banks that had excess capital used to lend money to the banks that weren’t able to maintain the SLR through Ready Forward Deals (RFD). RFD is essentially the short-term loans against government bonds as collateral.

However, most banks used to issue bank receipts instead of transferring the bonds. All these took place through intermediaries like stock brokers. Banks used to issue bank receipts to stock brokers, who would then lend to another bank. Harshad Mehta took advantage of the loopholes in this system by convincing banks to issue cheques in his name for buying and selling the bank receipts. Further, he bribed certain bank officials to create fake bank receipts.

He started using bank funds to inflate the prices of stocks. For repayment to banks, he would sell the stocks at the increased price. In other cases, he would just approach another bank and use their funds to repay the earlier banks. The bull run began. However, as the prices of many stocks were inflated artificially without the company actually being fundamentally strong or having growth prospects, soon the market started falling.

This made it difficult for Harshad Mehta to sell these stocks and he was no longer in the position to repay the RFD loans. This fraud of Rs. 4000 crores approx. was unearthed by Sucheta Dalal.

Aftermath: You already know what happened next. The Indian stock markets collapsed severely and several cases were lodged against Harshad Mehta. The scam further led to the suicide of the Chairman of Vijaya Bank and the resignation of P. Chidambaram. The banking system was on the verge of breakdown, with many officials being arrested. Around 40% of the market capitalisation was wiped from the Indian stock markets. Lakhs of families suffered severe losses.

The Ketan Parekh Scam

Another significant stock market fraud in India was done by the trainee of Harshad Mehta, i.e., Ketan Parekh. Like Teacher – Like Student, Ketan Parekh used the Pay Orders to scam the banks. A portfolio of stocks of certain companies was made known as K-10 companies. He used circular trading and pump and dump strategies to inflate the stock prices of these companies. 

He undertook massive borrowings from certain banks by bribing the banking officials, including Madhavpura Mercantile Co. Op. Bank (MMCB) and Global Trust Bank (GTB), without any collateral to invest in the stock market. Further, the owners of the company also paid him to inflate their company stocks.

However, after the dot-com bubble burst in 2001-2002, the stock prices fell dramatically. The banks mentioned above were close to bankruptcy and unable to pay their depositors. Upon an inquiry led by RBI, the Ketan Parekh fraud of nearly Rs. 40,000 crores was unearthed.

Aftermath: Madhavpura Mercantile Co. Op. Bank collapsed. The accumulated losses to the cooperative banking sector crossed Rs. 1598 crores. Ketan Parekh was banned from trading in the Indian stock market till 2017. After the Budget 2001 was presented, the stock market fell by more than 176 points. Ketan Parekh was arrested by CBI.

Again, many investors, including retail investors, institutional investors, and mutual funds, took a major hit.

The Satyam Scam

Another popular stock market scam in India that led to the tightening of various regulations was The Satyam Scam. This time, the real estate market was the foundation of this scam. Mr Ramalinga Raju was the owner of Hyderabad-based one of the fastest growing IT companies - Satyam Computers. During that time, real estate was booming in India. Further, based on the inside information about the Hyderabad Metro Rail project, he started buying land around the proposed metro route.

However, he was running short of funds to buy more land. Therefore, he decided to manipulate his company's stocks by resorting to window dressing. He started issuing fake invoices and manipulating bank statements to show higher sales and cash reserves. This directly increased the share prices of his company. He then sold his holdings in his own company such that it reduced to only 2% in 2009 from 24% in 1999.

However, the 2008 recession changed his fate. The real estate prices fell dramatically. Land owned by Mr Raju was no longer profitable. Further, the gap between fake revenue and real revenue increased to such an extent that he had no other option but to reveal his fraud. He revealed everything to SEBI and was later sentenced to imprisonment for fraud of nearly Rs. 7800 crores.

Aftermath: Ramalinga was sentenced to 7 years of imprisonment. It raised multiple questions on the laws, accounting practices, auditing and corporate governance in India and brought to the forefront, the loopholes that existed in various stages. Various changes were made in the laws, and special emphasis was put on corporate governance. 

Many committees were formed for recommendations and implementation of reforms and policies. Further, the Companies Act, 1956 was repealed by the new Companies Act, 2013 and amendments were carried out in the Listing Agreement. 

The Bottom Line

Stock markets were scammed of thousands of crores and not once but multiple times! Greed has always led to destruction. The above stock market scams in India shook the investors and raised questions about the integrity of the Indian Stock Markets.

It led to the most needed changes in the regulatory and legal environment to further prevent the loss of faith of the investors. Regulations and laws were tightened, severe punishments were imposed, and auditing provisions were made more stringent in order to avoid such malpractices and discourage misuse of the legal loopholes.