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There is a striking co-incidence between the two scams. Harshad Mehta’s Rs 5,000 crore scam (the Joint Parliamentary Commission pegged it at Rs 4,000 crore but market participants believe it was more than Rs 5,000 crore) and NSEL’s scam.
In case of NSEL, a large number of brokers tried to take advantage of a loophole in the system: Forwards’ contract in the NSEL to shore up commodity prices through investments from high networth individuals (HNIs).
The promise of high returns, in excess of 15%, was too much for the HNIs to ignore. The investors were given warehouse receipts (allocation letter). As it turns out, much of the goods do not exist.
Similarly, slightly-over two decades back, Mehta took loans from banks and financial institutions by faking receipts (ready forward deals). He assured them by assuring high returns. The money was used to artificially raise stock prices. For instance, the price of ACC shot up from a Rs 200 to Rs 9,000 -- a level the stock has never seen again.
The bubble burst for Mehta through a harmless incident. The State Bank of India (SBI) called Mehta to pay up Rs 500 crore which he had taken as loan. He arrived in his famous Lexus and made news. While he returned the money, doubts were raised on how was he able to acquire such large funds.
Mehta used the ready forward (RF) deal. Banks, in those days, used the RF to lend to another bank for the short term (say, 7-15 days) for a commission. The loans were given against government securities.
Mehta gave this mechanism a little twist. He took the loans, but without the securities. The money was used to drive stock prices, especially those did not have free float. In other words, there was no actual buying or selling happening. But in the absence of a buyer/seller, the stock prices kept on shooting up.
Similarly, in the NSEL case, the buyer and seller were same. That is, buyers pushed up the prices of commodities artificially by taking funding from brokerages (and their investors). Brokerages earned money by selling it in the forwards contract to the same buyer.
There was no actual delivery. The system again went on smoothly till the ministry of consumer affairs banned the forwards contract. The brokers rushed to seek money from the exchange (which had given the counter guarantee). But buyers such as N K Proteins and others did not have the cash to pay.
The aftermath: Mehta was banned from the stock market. One banker committed suicide and some others were sacked. In NSEL's case, seven people, including Anjani Sinha (CEO) and CFO have stepped down and will help in the recovery process.
The tragedy: Hundreds and thousands of stock market investors who invested in the Mehta-driven companies lost money. They never recovered the money. NSEL has paid around 600-odd investors who invested Rs 2 lakh or less, another 6000 plus investors, with investments of less than Rs 10 lakh, have been paid 50%. The rest will have to wait.
Lessons learnt: None. Ketan Parekh followed a similar approach just eight years later. In fact, in early 2000, Mehta in his avatar of corporate advisor drove stock prices of several companies.
Let’s wait for the next scam!
