Dr Navjeet Sidhu Kundal

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Securities
Scams
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Background

▪ Before 1991, Indian financial system was heavily regulated.

▪ No on-line trading in securities markets.

▪ Brokers played an important role in bringing together buyers and sellers.

▪ Banks were not free to use a large percentage of their time and demand
deposits due to CRR, SLR and priority sector lending.

▪ In 1991, financial sector reforms were introduced as a part of broad

economic reforms and suddenly profitability became important for banks.

▪ Banks were dealing in government securities through brokers.

▪ Harshad Mehta, a broker at BSE, saw this as an opportunity to make quick

profits.
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Description of Crisis

▪ Mehta squeezed money out of the banking system through ready

forward deals and diverted it to stock market.

▪ Mehta, the Big Bull, speculated in select securities and BSE Sensex
rose to record heights.

▪ Profits were shared with Banks.

▪ Fake bank receipts were used to siphon off funds from banks.
Sucheta Dalal, an investigative journalist of TOI, exposed the scam
through her column.

▪ The Janakiraman Committee set up by the RBI estimated that banks

and investors lost more than ₹ 4,000 crore due to scam.
◤
Contd…

▪ Harshad Mehta a stockbroker and started his own securities firm in 1990- “Grow
More Research & Asset Management Limited”. He was reputed and revered in the
markets. Being considered the “Sultan of Dalal Street”, investors blindly followed
Mehta’s footsteps. Mehta misused his status to manipulate the stock prices of
certain shares on the scrip for his personal financial gain.

▪ Basically what Harshad Mehta did was invest large sums of money in a particular
share. Seeing him invest, the other shareholders and investors also invested in the
same shares. This resulted in unnatural pumping of money into the stock markets
causing a rise in the price of these shares on the scrip. Unnatural inflation of stock
prices resulted in the Bull Run This Bull Run increased the share price of
companies like Associated Cement Company (ACC), the first company Mehta
invested in in the stock markets, from Rs.200/- to Rs.9000/- a 4400% increase over
the course of 1 year (1991-1992).
◤
Contd..

▪ The above operation though immoral was not illegal but the problem
arose because Mehta obtained capital to invest in the stock markets
by misappropriating banks’ money.

▪ When banks gave Mehta cash to purchase government securities

owned by other banks, he invested this money into the stock markets,
sold the purchased shares at a profit after a period of 7 days or so
and then completed the purchase of government securities. The
money handed over to Mehta was given for a specific purpose and he
wrongfully used the money for personal gain. This fell within the
scope of money laundering. Thus, Mehta made approximately Rs.
5000 crores by investing misappropriated money in the securities
markets.
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Contd…

▪ Mehta owned 50 lakh shares of more than 130 companies. When his scam
was revealed by Sucheta Dalal, a renowned journalist of the time, he
offloaded most of his shares to save himself from prosecution. The investors
felt that they had been cheated by Mehta and sold of their shareholdings in
order to safeguard themselves This unabated selling caused the markets to
lose Rs. 0.1 million in 1 day.

▪ SEBI, having no authority to regulate the transactions between investors

and brokers, was handicapped. The only authority with the jurisdiction to
look into the matter was the Central Bureau of Investigation (CBI).

▪ The government was made aware of this major gap in the regulation of
securities markets and after introspection they decided to bestow SEBI with
greater powers promoting it to the status of “market regulators”. In lieu of
this, the Legislature speedily approved the SEBI Act, 1992.
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Modus Operandi

▪ Modus Operandi:

▪ Price/Volume Rigging

▪ Insider Trading

▪ Ballooning BSE Index.

▪ Bank Fraud

▪ Impact:

▪ Scandal involved more than ₹24,000 Crores of public money.

▪ BSE index fell from 4500 to 2500 representing a loss of Rs. 100,000 crores
in market capitalization.
◤
Contd…

▪ This scam occurred due to use of illegal bank money for share transactions.
The initial public offers (IPOs) were weapons used by public sector
companies to generate the capital from the market. The amount raised, was
required to be deposited separately by the bankers and to be given to the
companies. But in some cases, the money was not immediately deposited
with the companies.

▪ Instead, the same money was temporarily used for investment in shares for
a short period of time. This money was used to have additional capital gain
of short term nature. Artificially, liquidity and demand for stocks was created
with the use of this money. This resulted in sudden and artificial Bull Run in
the stock exchange during 1991-92. From April 1991 to June 1991, the
SENSEX rose to 1361 from 1193(more than 16% in 2 1/2 months.)
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Contd…

▪ By December 1991, it reached 1915 points and further to 2302 in January 1992 to 4467 on
April 1992.

▪ This was an unprecedented growth in SENSEX. An amount of Rs.3650 Crore was pumped
in into the market by this illegal way.

▪ After April ‘92, when the amount was to be taken back by these brokers, the market crashed
and within a week SENSEX came down by more than 10%. Some of the notified brokers
and companies involved in this scams apart from Harshad Mehta, were- Fairgrowth
Financial Services Ltd., Hiten Dalal, Bank of Karad, Bhupen Dalal, T.D. Ruia, A D Narottam
etc. In all, this scam was a deliberate misuse of public money through securities transactions
with an intention to get speculative return. The lacunas which allowed this scam were non
transparency and non- accountability of the banking system, absence of governance in
capital market, lack of awareness of investors, information inefficiency etc. Extensive use of
bank receipts was made by the intermediaries involved in the scam for forward transactions

▪ After the exposing of the Scam Harshad Mehta was charged with over 600 civil cases and
70 criminal
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Ketan Parekh Scam
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Genesis

▪ In Spite of the recommendations made by the Janakiraman Committee Report in 1992 to

prevent security scams from happening in the future another security market scam took
place in 2001.

▪ This involved the actions of one major player by the name of Ketan Parekh. He manipulated
a large amount of funds in the capital market through a number of his own companies which
is probably why the scam remained a mystery for quite some time the RBI, SEBI and DCA
(Department of Company Affairs) had gone slack in their regulatory operations.

▪ During 1999 and 2000 the SENSEX reached a high and after than the stock market crashed
in 2001. Some of the major companies he invested in were Nirma, Adani Group, Essel
Group, DSQ and Zee Cadila. Ketan Parekh manipulated the stock market through FII's
(Foreign Institutional Investors), OCB's (Overseas Commercial Borrowings), Banks and
Mutual Funds (Unit Trust of India). In fact an important extension of this scam remains the
Unit Trust of India Scam.
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Contd…

▪ Modus Operandi:

▪ Price/Volume Rigging

▪ Circular Trading

▪ Front Running

▪ Impact:

▪ BSE Sensex crashed badly.

▪ Large scale losses to investors, including large institutional

investors, insurance companies and mutual funds.
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Contd…

▪ His portfolio comprised of 10 handpicked stocks, which is also known as the K-10 stocks. The market
always predicted the future of these stocks to be bullish. He traded in the Kolkata stock exchange which
happened to advantageous to him due to the lack of regulations. From 1999 to 2000 he ruled the stock
market.

▪ Ketan Parekh scam case involved two key strategies, namely “circular trading” and “pump and dump
scheme”.

▪ Pump and dump are where he would purchase 20 to 30% of the share of a company in order to cause a
price rise. The increase in price will subsequently tempt other investors to invest. Once the prices have
skyrocketed, he would simply dump them to make an exit by liquidating his holdings.

▪ Circular trading is a strategy where he made a few amateur or junior traders to buy and sell frequently
certain shares throughout the day on his call. This caused the “traded volumes” to go up significantly. The
investors who base their decisions on the volume traded will consider such stocks to be active and make an
investment. Once the prices shoot up he would make a profit out of it and also pay the traders a small
commission. This trading via primitive traders is popularly known as the Badla system.
◤
Contd…

▪ In simple words, a pay order is like a cheque but issued by the

bank on payment of a small advance by the customer. He
brought shares of Madhavapura Mercantile Commercial Bank
(MMCB) in order to manipulate its loan decisions. Then he went
forward to get a huge loan from MMCB in form of payment
orders and when the prices shot up he pledged them with other
financial institutions like HCFL and UTI. Nearly 1.3 million pay
orders were issued. He did so until the early period of 2000. His
loan amount accounted for 750 million. He also bagged huge
amounts from promoters and owners of the company in order to
make the share prices of their companies to go up.
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Contd…

▪ Some of the major stocks he invested in were Aftek Infosys,

DSQ software, Satyam computers, Zee telefilms, Himachal
Futuristic, Silverline technologies, etc. The price of Zee telefilms
shot up from Rs. 127 to Rs. 2330, Visual soft touched Rs. 8448
from Rs.625 in no time. He recorded a 200% interest on the
value of certain stocks.

▪ As a result, SEBI brought in various rules and regulations. It

banned the Badla system and circular trading. It inspected all
the accounts relating to the stock exchange yearly once.
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Sahara Scam
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Introduction

▪ SEBI alleged that Sahara India Real Estate Corp. Ltd. (SIRECL) and Sahara Housing Investment Corp. Ltd.
(SHICL), which issued Optional Fully Convertible Debentures (OFCD), illegally collected investor money.

▪ Meanwhile, Sahara denied SEBI had any jurisdiction in the matter. SEBI went on to order Sahara to issue a
full refund to its investors, which was challenged by Sahara before the Securities Appellate Tribunal. When
the SAT upheld SEBI’s order, Sahara moved to the Supreme Court in August 2012, which ordered.

▪ Sahara to refund investors’ money by depositing it with SEBI. Sahara then declared that most of the US
$3.9 billion had already been repaid to investors, saves for a partly US $840 million, which it handed over to
SEBI. This was disputed by SEBI, which claimed that the details of the investors who were refunded had
not been provided. When Sahara failed to deposit the remaining money with SEBI and Subrata Roy skipped
his hearing, the Supreme Court of India issued an arrest warrant for the Sahara chief in February 2014.
Amid rumors of black money laundering and the misuse of political connections, Sahara vehemently denied
all charges and continued to defy SEBI. The regulator persevered through what the Supreme Court referred
to as the “ridiculous game of cat and mouse” and finally managed to pin down Sahara chief Subrata Roy in
2014. In this rare victory, SEBI not only brought Sahara to justice, but also made an excellent case for why
the regulator, and others like it, require greater autonomy and penalizing powers.
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Contd…

▪ Modus Operandi:

▪ Illegal Money Collection from investors Circumventing provisions of public issue

▪ Non-disclosures/False disclosures

▪ Diversion of funds

▪ Re-payment default

▪ Impact:

Huge monies approx. 24,000 Crore were raised from over 3 crores investors, without following
the norms for bringing a public Issue i.e. IPO.

As per reports, the total dues from Sahara went

up to Rs 40,000 Crore with the accretion of interest.

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Contd…

▪ Sahara India Parivar, founded in 1978 by Subrata Roy, is one of

the largest conglomerates of the country.

▪ Its businesses range from media to housing projects.

▪ As on March, 2014, the Sahara Parivar had a net worth of Rs.

68,174 crores, an asset worth of Rs. 152,815 crores, a
landholding of 36,361 acres and a depositor base of 5.1 crore
people; all this within 40 years of its existence.
◤
Contd…

▪ Sahara India floated 2 new companies- Sahara India Real Estate Corporation Limited
(SIRECL) and Sahara Housing Investment Corporation (SHIC) in 2005 by registering them
under the Companies Act, 1956 with the relevant Registrar of Companies in Kanpur and
Maharashtra respectively.

▪ In theannual meetings held by both the companies, a resolution was passed to raise funds
through private placement of optionally fully convertible debentures (OFCD‘s) from the
friends, associates, and family members of the Board of Directors.

▪ Funds were also to be raised through the circulation of an information memorandumto a

few trusted investors. The date of commencement of issues of the debentures was 25th
April, 2008 and 20th November, 2009, respectively. SIRECL collected Rs. 17,656.53
crores (net value) between 25th April, 2008 and 13th April, 2011. SHICL collected Rs.
6373.20 crores (net value) between 20th November, 2009 and 13th April, 2011.

▪ Thus both the companies collected Rs. 24,029.73 crores from 30 million investors over a
period of 3 years. In 2009, when a red herring prospectus for Sahara Prime City (a real
estate venture of Sahara India) was submitted to SEBI for approval, SEBI noticed unusual
fund raising activity in the 2 firms- SHICL and SIRECL
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Contd…

▪ 4th January, 2010, SEBI received a complaint from a man,

RoshanLal, who alleged that ―illegal means were being used
by SHICL and SIRECL in issuance of OFCD‘s.

▪ Following this, SEBI launched an investigation against Sahara

India, inquiring into the fund raising activities of SHICL and
SIRECL along with investor information. On receiving stiff
resistance from Sahara, SEBI passed an interim order
confirming that there was illegal activity with regard to issuance
of OFCD‘s and instructed SHICL and SIRECL to refund the
money to the investors with interest.
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▪ Following this, Sahara filed a petition in the Court asking for a

stay order. Since Sahara was not co-operative with the
authorities, eventually the stay order was vacated and a final
order was passed by SEBI on 23rd June, 2011. Even the
Securities Appellate Tribunal (SAT) approved the SEBI order on
18th October, 2011.

▪ After this, Sahara appealed the SEBI order in the Supreme

Court, questioning their jurisdiction in the matter and alleging a
defamatory agenda on part of SEBI to destroy the market
reputation of Sahara India.
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Supreme Court Judgement Dated 12th
August, 2012

▪ Sahara India Real Estate Corpn. Ltd. V. SEBI, (2013) 1 SCC 1

▪ The judgement upheld the SEBI order and ordered Sahara to

pay Rs. 24,400 crores (after including the interest and adjusting
the redemption vouchers) to SEBI in 3 installments within 4
months along with investor information. SEBI was then to
distribute the money to the investors on behalf of Sahara.
 Whether SEBI has jurisdiction over the matter under S.55A of
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the Companies Act, 1956?
▪ Section 55A of the Companies Act delegates certain powers relating to issue and transfer of securities to
SEBI. It reads as follows:

▪ "55A. Powers of Securities and Exchange Board of India –

▪ The provisions contained in Sections 55 to 58, 59 to 81 (including sections 206, 206A and 207, so far as they
relate to issue and transfer of securities and non-payment of dividend shall, --

▪ in case of listed companies;

▪ in case of those public companies which intend to get their securities listed on any recognized stock
exchange in India, be administered by the Securities and Exchange Board of India; and

▪ in any other case, be administered by the Central Government.

▪ Explanation – For the removal of doubts, it is hereby declared that all powers relating to all other matters
including the matters relating to prospectus, statement in lieu of prospectus, return of allotment, issue of
shares and redemption of irredeemable preference shares shall be exercised by the Central Government,
Tribunal or the Registrar of Companies, as the case may be."

▪ From the aforementioned it can be gathered that (i) listed companies and (ii) those intending to get listed are
companies subject to the jurisdiction of SEBI. What would tantamount to 'intending to get listed' was a
question before the SC. The SC while answering this question described in great detail the role of SEBI as
an institution to promote orderly and healthy growth of the securities market and for investors’ protection.
Against this backdrop, the SC analyzed the contentions of the Appellants and the relevant laws.”
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Contd….

▪ The Appellants argued that they never intended to list the

OFCDs, and hence the issuance fell outside the purview of
SEBI. This contention was rejected by the SC. The SC in
analyzing this aspect went by the conduct of the Appellants and
stated that a ‘company's option, choice, election, interest or
design does not matter, it is the conduct and action that matters
and that is what the law demands’. Since, in this instant case,
the issue of OFCDs was held to be a public issue, which
entailed a listing, the SC held that the Appellants were seen to
have intended to get their securities listed.
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Public issue versus private placement
▪ Whether Section 67 of the Companies Act implies that a company’s offer of shares or
debentures to 50 or more persons would ipso facto become a public issue, subject to certain
exceptions provided therein?

▪ As stated above, only if the Applicants issue of OFCDs was held to be a 'public issue' would
the same be subject to SEBI jurisdiction. It was not in dispute that there were more than 50
offerees or subscribers to the issue of OFCDs by the Appellants. The contention of the
Appellants was that the number of allottees or offerees was immaterial in determining
whether an offer was a public issue – it was the intention that mattered. The intention to offer
to a select or identified group would make the offer a private placement. To support their
argument the Appellants relied on the Unlisted Public Companies (Preferential Allotment)
Rules, 2003 which do not stipulate a limit to the number of persons that a preferential
allotment may be made.

▪ The Court rejected the arguments of the Appellants and relied on Section 67 to conclude
that an offer to 50 or more persons constitutes a public issue, and hence the issuance of
OFCDs by the Appellants was a public issue. To arrive at this conclusion, the SC also lifted
the veil to examine the conduct and method adopted by the Appellants and placed reliance
on inter-alia the following to determine that even in spirit the issuance by the Appellants was
a public issue:
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Contd…

▪ Listing in case of public issue: In terms of Section 73, is every company

making an offer of securities to 50 or more persons required to apply for
listing of its securities on a stock exchange?

▪ The SC stated that Section 73(1) of the Companies Act casts an obligation
on every company intending to offer shares or debentures to the public to
apply on a stock exchange for listing of its securities. Such companies have
no option or choice but to list their securities on a recognized stock
exchange, once they invite subscription from over 49 investors from the
public. If an unlisted company expresses its intention, by conduct or
otherwise, to offer its securities to the public by the issue of a prospectus,
the legal obligation to make an application on a recognized stock exchange
for listing starts.
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Securities include hybrid: Are hybrid instruments also with the ambit
of the SEBI to regulate?

The Appellants had contended that whereas pursuant to the

Companies Amendment Act the definition of the term 'securities'
was modified to include a "hybrid" instrument Section 67 of the
Companies Act was not amended to include ‘hybrids’ and continued
to refer only to offer of shares or debentures. Therefore, since
OFCDs are hybrids, they should be outside the purview of Section
67 of the Companies Act.
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Contd…

▪ However, the SC rejected the above contentions. It stated that the OFCDs issued by the
Appellants undoubtedly were unsecured debentures by name and nature. Though, they
have the dual characteristics of shares and debentures, as defined by the term "hybrids",
however, they continue to remain debentures till the time they are converted. In other words,
OFCDs issued by the Appellants are debentures in presenti and become shares in futuro.
Further, the SC also stated that the definition of "debentures" in Companies Act includes
'any other securities', and noted that the Appellants have treated OFCDs only as debentures
in the IM, RHP, application forms and also in their balance sheet.

▪ Further, on the contention of SEBI’s jurisdiction over OFCDs, the SC stated that the
definition of "securities" in the SCR Act is an inclusive definition and not exhaustive. Further,
the definition of “securities” in the SCR Act includes any "other marketable securities of like
nature". The SC stated that any security which is capable of being freely transferable is
marketable. Since, the OFCDs issued by the Appellants were freely transferable, therefore,
they fall within the purview of "securities" in the SCR Act.
◤
Karvy Stock Broking Scandal –
Unauthorized Trading: 2019

▪ Modus Operandi

▪ Misusing client’s funds

▪ Unauthorized trading into client’s account Impact

▪ Investors lost money

▪ Investors Lost faith in Market Intermediaries

◤
Contd…

▪ Karvy is one of the biggest stockbroking firms and has millions of

clients who it serves. These clients instruct Karvy on a day – to – day
basis to execute their market transactions. Karvy needs a Depository
Participants account to execute these transactions after which these
are transferred to Client’s Account. To enable Stockbroker here Karvy
to seamlessly carry out these transactions, Client had signed a Power
of Attorney authorizing Karvy to do the process. Karvy took undue
advantage of this situation opening another Demat Account in its own
name and transferred all the securities in its fake account using the
Power of Attorney and delaying the payout to clients citing the reason
of technical glitches.
◤
Contd…

▪ Once the securities were transferred to its fake account under the name of
Karvy, Karvy approached various financial institutions to raise money and in
turn utilised these amounts for its real estate business named Karvy Realty.

▪ Using this unethical method Karvy raised around 1200 crores, when some
clients complained about the delayed payouts to SEBI, a forensic audit was
carried out by SEBI wherein the issue of fund diversion by Karvy came in
light where it acted in bad faith. Karvy’s license was cancelled and it was
ordered that all the shares pledged with Financial Institutions be returned to
the Clients of Karvy. Till now 90% of the shares are transferred and the
Demat with Karvy was to be closed and securities to be transferred to the
new account.
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Contd…

▪ SEBI, in its circular dated April 23, 2019 laid down guidelines for the
execution of PoA by the clients in favour of the stockbroker after noting
irregularities and misuse of the document. Brokers were mandatorily asking
clients to execute irrevocable and general PoAs in their favour, and then
using them to execute unauthorized trades in their client’s names. SEBI
mandated brokers and depository participants to comply with the guidelines
laid down. SEBI limited the scope of the PoA to, first, the transfer of
securities held in the beneficial owner account of the client towards stock
exchange related margin and delivery obligations, second, pledging of the
securities in favour of stock broker for the limited purpose of meeting the
margin requirements, and third, to apply for various products like mutual
funds, public issues, rights, etc. pursuant to the instructions of the client.
Furthermore, it explicitly prohibited PoAs that facilitated off market trades, a
charge that Karvy has been found guilty of.