Behind Scam 1992: The Basics of the Securities Market

The Securities Scam of 1992 was a revelation. It opened up the eyes of the public to the volume of funds that pass through the Securities (Stocks and Debts) Market every single day. Almost three decades later, the 1 billion $ scam is back into popular culture and public spotlight with representation all over the web; and it is just as shocking to the people as it was in 1992.

The background of the Securities Market can often be complex and pretty difficult to understand, even if you’ve binged the Harshad Mehta web series more than three times. So, here is Declassified’s breakdown of the basics of the Securities Market:

What is a Stock?

Harshad Mehta’s infamous career revolved around the Stock Market: whether it was his beginnings as a simple, grassroots jobber in the BSE or his eventually investing crores and crores of funds in the Stock Market through his consultancy firm.

The Bombay Stock Exchange, situated in Dalal Street of Mumbai.

A stock (also known as equity or shares) is a type of security that represents the ownership of a fraction of a corporation (for example: Reliance). This entitles the owner of the stock to a proportion of the corporation’s assets as well as profits equal to how much stock they own.

 Who are the players in the Stock Markets?

Much like any other market prerequisite, the Stock Market too mainly has two players: buyers and sellers.

The facilitation of these exchange transactions, however, is done by the stockbrokers or consultancy firms, A stockbroker is any middleman who has the authority to buy and sell stocks and securities in a stock exchange on the investor’s behalf. Harshad Mehta headed one of the most successful consultancy firms of its time: Grow More Research and Asset Management. His main role as broker and consultant was providing information that helps an investor make correct investment decisions.

Where there is a market, there has to be some form of regulation. This is where comes in the SEBI (Security and Exchange Board of India), the RBI (Reserve Bank of India), and the government itself. The security transactions have to conform to government regulations which are meant to protect investors from fraudulent practices. It was the investigation perpetuated by these statutory and regulatory bodies that exposed the Securities Scam of 1992.

What determines the stock price?

Alfred Marshall’s basic demand-supply model is used for the price determination of any stock.

Stock prices are a function of supply and demand, although other influences, such as earnings of the company and the economy in general, can easily affect the desirability of owning or selling a particular stock. For example, when Harshad Mehta backed a particular stock, it was solely his reputation that drove up the demand for these stocks. Through cornering off the larger percentage of shares with the exorbitantly high funds available to him, Mehta also limited the supply in the open market.

He thus made immense profits in his role as a commission-based stockbroker. Stocks like ACC, which were trading in 1991 for ₹200/share, catapulted to nearly ₹9,000 in just 3 months. This is the ‘Big Bull Effect’ that Harshad Mehta had on just one share.          

What is a bull market and bear market?

When the stock market is doing well and all the share prices are on the rise, it is said that the market is “bullish.” The term can also be used for an individual stock that shows a constant rise in prices. When a stock is on a bull run, it means that the stock is doing very well.

As the “Big Bull”, Mehta was known to take his favoured stocks on a bull run, driving up the prices of stocks like ACC, Videocon, TESCO, Reliance, etc. extensively.

On the other hand, a bear market occurs when the overall market sentiment is low or negative and share prices are on the decline. While in a bull market, people are buying more stocks than they are selling, the reverse is true in a bear market.

As they see a decline in share prices and a further weakening of the economy, they start selling stocks in large numbers and flooding the market, causing a further decline in prices.
The Bear Cartel of the BSE operated on this system, and thus were widely regarded as Harshad Mehta’s arch-nemeses due to their opposing goals and systems to gain profits.

Measuring the Changes in Stock

The BSE, or the Bombay Stock Exchange, situated in Dalal Street of Mumbai, is where stocks are constantly bought and sold predominantly every day. SENSEX, or the ‘Stock Exchange Sensitive Index’, is the principal metric of indicating the performance of the whole BSE.

In the time of Harshad Mehta, SENSEX and NIFTY has had a rollercoaster ride with its figures. In the period between April 1991 and April 1992 (the peak of the Scam), the SENSEX went into a frenzy and returned 274 percent, moving from 1,194 points to 4,467. That is the highest annual return for the index.

After news of the Scam broke, the index fell from 4500 to 2500 points, representing a loss of Rs. 1000 billion in market capitalisation. This rapid fall was the largest the stock market had ever seen.

What is the money market?

The money market involves overnight swaps of vast amounts of money between banks and the government in form of liquid money, bonds, government securities, and debt instruments. The majority of money market transactions are wholesale transactions that take place between financial institutions and companies to manage the liquidity of funds.

Harshad Mehta shifted his focus from the Stock Market to the Money Market in order to gain access to the exorbitantly high volume of funds that are shifted around in these transactions. While acting as a broker between two parties, he siphoned off these inter-bank funds to drive up stock prices in the BSE and profit off of them.

Since it is a huge industry which involves large-volume trades between institutions and traders, Harshad used the funds for his stock market operations, and sent stock prices soaring up by a staggering 4,400 percent: from around 1200 to a record high of 4467. Clearly, the money from the banking system was flooding the stock market and driving stock prices higher.

The Outcome of 1992:

Harshad Mehta impacted the entire system of the Securities Market. With the collapse of BSE, investors lost lakhs and lakhs of rupees in the Stock Market. The index fell from 4500 to 2500 points representing a loss of over Rs. 1000 billion in market capitalisation. This rapid fall was the largest decline that the Stock Market had ever seen, and investor confidence was at an all-time low.

However, the scam also resulted in a completely reformed system of stock transactions and an introduction of online security systems. The Securities Laws (Amendments) Act was passed in 1995, widening SEBI’s jurisdiction and regulatory powers. The sweeping stock market reforms were a huge step in covering for any further flaws in the system.

Sucheta Dalal being awarded the Padma Shri for Journalism.

However, less than a decade later, came to light the revelation of the huge Ketan Parekh stock scam. As Sucheta Dalal, the industry-leading journalist who broke the 1992 Securities Scam, says, “Only in India will you find two scams that are so identical and which took place within a span of just 10 years.”

– Anuj Khare (Writer, Econ Declassified)

References:

  1. Damachis, B. (2017, May 10). The Bombay Securities Scam of 1992: The Systemic and Structural Origins. Retrieved from Policy, Organisation and Society: https://www.tandfonline.com/doi/pdf/10.1080/10349952.1994.11876795
  2. Almeida, A. (2020, December 21). Harshad Mehta Scam- How one man deceived entire Dalal Street? Retrieved January 15, 2021, from https://tradebrains.in/harshad-mehta-scam/
  3. Palande, P. (2014, August 12). Economic Milestone: Stock Market Scam (1992). Retrieved January 15, 2021, from https://www.forbesindia.com/article/independence-day-special/economic-milestone-stock-market-scam-(1992)/38457/1
  4. Ranking, R. (n.d.). Decoding The Stock Market Scam of 1992 by Harshad Mehta. Retrieved January 15, 2021, from https://researchandranking.com/blog/stock-market-scam-of-1992-by-harshad-mehta
  5. 1992 Indian Stock Market Scam. (2021, January 10). Retrieved January 15, 2021, from https://en.wikipedia.org/wiki/1992_Indian_stock_market_scam#In_popular_culture

To subscribe to our monthly e-newsletter and updates related to Economics Declassified, click here.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s