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.
The best thing however is that Indian markets have remained
amongst the safest in world in past two decades. We were perhaps the only
market in India that did not impose any trading restrictions during global
financial crisis.
The recent measures taken by SEBI and Stock Exchanges to tighten
the margining norms to dissuade excessive speculation have been severely
criticized by market participants. However, in my view, COVID-19 has warranted
SEBI to consider Negative Commodity price and Act of Gods as White Swans for
risk management system for securities market. I therefore expect even further
tightening of margining and compliance norms.
