Frauds in the Indian Capital Market
In 2016, the economic times published an article titled ‘Every amendment to SEBI came after the grave episode’ these words were said by SEBI’s then chief UK Sinha . The stock market has been shaped by passing many laws and regulations. Stock market is a complex financial structure with the task of managing billions of rupees. The collapse of the stock market can badly harm the economy. Unfortunately, the Indian stock market has been subject to many scams and frauds leading to loss of value and investors trust. The laws which govern the SEBI are passed after the many such frauds and scams to reduce the chances for them to occur in future.
Harshad Mehta Scam 1992
The Harshad Mehta scam costed rupees four thousand crore. Harshad Mehta committed a crime that exposed the weakness of the Indian stock market and is greatly responsible for its reforms. He took the advantage of the poor coordination of the banking system and the stock market. He involved the premium banking institutions like the State Bank of India and the National Housing Bank. The biggest reforms after the scams include the increase in SEBI’s jurisdiction over the Foreign institutional Institutions (FII), the credit rating agencies, venture capitals etc. The system of taking stock delivery by the broker is greatly amended where earlier it was two weeks now it has been reduced to two days. The paper trading has been replaced with electronic trading making the information more accessible to the investors. Former SEBI chairman UK Sinha said ‘That SEBI’s foundation was laid in 1988, but it was the Harshad Mehta scam which led to the enactment of SEBI Act ,1992.’. This scam changed the approach towards investor protection in India. Mehta soon died and that time he had seventy-six criminal and six hundred civil law suits pending against him.
The Ketan Parekh Scam 2001
In 2001, the Indian stock market received another blow due to fraud committed by Mr. Ketan Parekh. In this scam the investors lost up to 2000 crore i.e., $ 4 billion. He like Harshad Mehta took the advantage of the gaps and loopholes of the stock market and the banking system in India. The leniency and mismanagement on the part of the sectoral regulators proved to be harmful for the small investors. Ketan Parekh also manipulated the stock market by creating a demand for certain stocks popularly known as the method of pump and dump and then by way of circular bidding. In order to pump up the stocks of some companies, he took huge funds from the Banks, institutional investors etc. He mostly conducted his trading through the Calcutta stock exchange and lack of regulations in it made it easy for him to manipulate the market.
Changes happened post the Ketan Parekh scam
Post the Ketan Parekh scam many investors lost their money and the Calcutta stock exchange faced huge losses. Post the scam, SEBI took some serious measures like restricting the circular trading from one week to a day. Also, the SEBI (Amendment) Act,2002 was passed in which some of the significant changes were passing of section 11A of the SEBI Act in which the issuing of prospectus, offer documents and advertisement asking for investments were introduced. Section 11(4) gave the powers to the board to suspend particular traders to safeguard the investors. Laws to regulate Insider trading, Takeover and deceptive trades were introduced.
Satyam Computers Scam 2009
The Satyam Scam, yet again highlighted the loopholes in corporate governance practices in India and the leniency of SEBI proved to be fatal for the small investors again. In this case, the founder and former chairman of Satyam Computers, B Ramalinga Raju and his brother B Rama Raju committed the defrauded the board, investors and other stakeholders. The books of the company lied about its financial status and investments.
Mr Ramalinga invested in Real Estate in the different parts of the nation and took the money form the company’s account by misrepresenting the figure in the books of accounts. Resultantly the share prices soared but the fundamentals of the company remained the same.
Eventually, when the real estate industry devalued, Mr. Ramalinga could no longer sell the properties owned by him to fill the gaps of the books of account and he was subsequently convicted for the same. The Satyam fraud costed Rs. 7,136 crores. The scam exposed a web of people involved in making the scandal possible from Auditors to board of directors. In 2009 the books of accounts of Satyam Computers showed a profit of Rs. 5200 crores whereas the real profit was onlyRs,4100 crores with a growth percentage of 3% in contrary to 24% which was shown in the books of the company. The pronounced growth in the fundamentals of the company lured the investors to own a stake in the company which looked very promising at the time. Post the confession of Mr. Ramalinga he along with his brother was jailed for seven years along with a fine of Rs. 5 crores.
Changes happened post the Satyam Computers scam
In 2014 SEBI established the Vigil Mechanism. In 2015 SEBI framed the SEBI (Listing and disclosure requirements) regulations, 2015 which is applicable to all the listed companies and compels the companies to take measures to creates transparency and disclose major information. The companies Act, 1956 was repealed and replaced by with Companies Act 2013 the act has well defined provisions of corporate governance and a wider control of the government of upon the companies with a higher degree of transparency. The 2013 Act carries stringent laws for related party transactions in order to lessen the risk of financial frauds.
The Sahara Scam 2010
The Sahara Scam was again an infamous incident of the Indian Capital Market. This scam first came under the SEBI’s radar when the Sahara group wanted to list the share of Sahara Prime City. While analysing the red herring prospectus of this company, SEBI noticed a number of irregularities regarding the funding raising process of two companies of the Sahara Group Sahara India Real Estate Corporation and Sahara Housing Investment Corporation Ltd. SEBI investigated into the matter and a misappropriation of funds amount to Rs. 24000 crores surfaced, this money was collected from 2.5 crore and more small investors. This amount by raised by means of optionally fully convertible debentures (a form of hybrid security). SEBI objected to this issue and asked the company to return the money to the investors along with interest. The Sahara group, thereafter, challenged SEBI’s jurisdiction in the matter as hybrid security does not come under the jurisdiction of SEBI but the Registrar of company under the ministry of corporate affairs. SEBI ‘s power to investor protection in certain types of securities was questioned by the Sahara group. SEBI ordered the two companies to not to issue any more optionally fully convertible debentures (OFCD). This order of the SEBI was challenged by the Sahara group in the Allahabad High Court which restricted SEBI’s order but eventually cancelled the restriction and the case was then appealed in the Supreme Court. In 2012, The Supreme Court also ordered both companies to return the money to the investors with an additional interest of fifteen per cent. Supreme court ordered the companies to deposit the money with SEBI within three months along with the details of the investors. The Sahara group could not provide the information of the investors to SEBI and also did not make the complete payment to the investors. As there was no information of the investors it was suspected to be a case of money laundering. The final order was passed by Supreme Court in 2014, in which Subrata Roy the chairman of the Sahara Group was arrested. In 2017, the group was charged for Money laundering.
Changes happened post the Sahara scam
Post the Sahara Scam, Investor protection became a serious matter of concern for the regulators.Throughout the legal battle between Sahara group and SEBI. The company claimed that SEBI does not have the right to investigate into this matter as it does not fall under its jurisdiction and the optional fully convertible debentures are not securities. Supreme Court in its Judgement passed on 31.08.2012 acknowledged that OFCD are securities as they were debentures issued to the public. The securities are regulated under the Securities contract regulation Act, 1956. This case widened the powers of SEBI to investigate and hold accountable any company in order to protect the small investors.
Section 11A and 11B of the SEBI Act, 1992 enable SEBI to take all the appropriate measure in order to protect the investors. As of March 2020, SEBI declared that the money returned by Sahara group stood at 115.2 crores. And this amount increased to 129 crore in 2021. Till date SEBI has filed various 22 status reports and SEBI is working closely upon this matter under Justice (Retd) BN Agarwal.
Shraddha Group Financial Scheme
Another chit fund scam emerged in 2013, Shraddha Chit fund committed a fraud amounting to Rs.1983 crores approximately. Shraddha was a group company and it came with the chit fund scheme in 2000. Sudipto Sen was the founder of the Shraddha group. The money in the scheme was collected through agents who were paid in commission. The number of investors in the scheme reached up to 1.7 million, it was mostly popular in the states of Odisha, Assam, Tripura etc.
In 2013, the company cash inflow was lesser than its outflows due to SEBI’s intervention. SEBI demanded the company to comply with its laws and regulation of the collective Investment scheme laws. SEBI asked the group to stop accepting money from the investors and take the permission to run the scheme further. The matter was first investigated by the special investigation team a taskforce setup by the West Bengal government and in 2014 was referred to CBI under the orders of the Supreme court.
SEBI investigated the matter with the probe whether the chit fund scheme complied with its Collective Investment scheme law. SEBI claimed that the way in which the Shraddha group raised the funds from public was against the law. SEBI’s again faced the issue of Jurisdiction in this matter as well, as chit funds are a subject matter of the state government. Chit Funds are dealt by the state governments and the states of West Bengal and Orissa did have laws to deal with the chit fund schemes. But a central law to regulate the chit fund scheme was promised by the then finance minister Mr. Arun Jaitley.
SEBI’s involvement in Shraddha Group Financial Scheme case
Section 11AA of the SEBI Act, 1992 excludes chit funds from the purview of the collective investment scheme. So, this case should ideally not fall under SEBI’s jurisdiction but SEBI got involved in this case, when it investigated the companies functioning and found out that it was not running chit fund but collective investment scheme which came under SEBI’s purview.
Changes happened post the Shraddha chit fund scam
As promised by the government a new bill to regulate chit funds on a central level was introduced. The bill was named ‘The banning of Unregulated Deposit scheme Bill ,2018’. Approach of the corporate governance changed after this case, it became mandatory to obtain a Certificate of Incorporation (CIN) and one can verify the details of company by checking the same on the website of ministry of corporate affairs.
National Spot Exchange Scam 2013
National Spot exchange scam was another big scam which shook the Indian Financial Market. It questioned the regulatory authorities and brokers intention towards investors protection. This scam greatly highlighted the government and regulatory bodies incapacity to overlook proper functioning of the companies entrusted with public money.
National Spot Exchange Limited was incorporated in 2005 under the companies Act, 1956.It was incorporated in order to facilitate spot exchange for trading commodities. In 2008 provided electronic platform to willing participants in the market to trade in the spot exchange commodity.
The commodity exchange market was largely unregulated. The Forwards Market commission, a body which was entrusted with the task of regulating the commodity market, demanded to regulate the spot exchanges and its warehouses. FMC was finally given the charge to fill the regulatory vacuum. Post resuming duties FMC found that the exchange allowed trading on its platform without cross checking whether the seller of the commodity at all had the commodity in stock and this led to false ordering of commodities. the provisions of the Contract Regulation Act, 1952 was widely violated. This scam costed 56000 crores to the public.
Changes happened post the NSEL scam
The Forward Markets commission was merged by SEBI post this financial scam as the authorities believed that SEBI has the better knowledge and expertise to deal with the commodities market. In 2015 the merger took place the reason given behind the merger was to make trading a global experience.
SEBI also started its investigation against several` broking firms. Under SEBI’s 2radar there were 111 brokerage firms, who had possible involvement in the scam. The government, post the scam withdrew the waiver given to the entities involved in spot exchange after the scam. The waiver was granted to NSEL, NCDEX and National APMC. Among these entities only NSEL got to use the exemption under the waiver. The waiver was granted under section 27 of the Forward contract regulation Act. Post the scam SEBI’s powers were increased manifolds and it got actively involved in the investigation in the along with Economic offence wing and CBI. SEBI punished stakeholders in order to protect the investors. NSEL was closed post the scam.
Mass Insider Trading of 2017 (WhatsApp leak case)
In the 2017 case. SEBI closely scrutinised the ‘forwarded as received’ messages on WhatsApp of personnel of few broking firms.These messages contained the Insider information regarding the fundamentals of the major companies reflected through their unpublished quarterly reports. Under the Insider trading regulation of 2015, framed by SEBI, leaking or passing of unpublished sensitive information (UPSI) regarding a company which can lead to the stock’s price fluctuation of that company in the stock market is punishable.
After receiving the tip by SEBI that price sensitive information of the companies is being circulated in WhatsApp groups led SEBI to take serious and firm actions under the law. And it brought brokers, auditors and other stakeholders under the radar. A few brokerages were also penalised by SEBI.for forwarding the UPSI of few companies.
The employees of these brokerage firms appealed SEBI’s decision in Securities Appellate Tribunal (SAT). SAT after a close scrutiny set aside SEBI’s order of the employees being Insiders for forwarding the price sensitive information. SAT for its judgement gave the reason that SEBI was not able to find the point of origin of this financial fiasco. Hence, putting the blame on the people for just forwarding a message should not be held against them.
The defendants took the plea of the practice of ‘Heard on street’ (HOS) these are the tips or unsubstantiated information regarding the companies which are easily available through various media platform and prosecution on this common information received through WhatsApp messages should not be held against these brokers.
Changes happened post theMass Insider Trading of 2017 (WhatsApp leak case)
Post this scam, SEBI became more proactive to analyse the cases of leak of UPSI from the social media platforms and in that regard, it introduced the SEBI (Prohibition of Insider Trading) Amendment Regulation in 2018. This amendment primarily focuses about the ways in which the leakage of UPSI can be curtailed. SEBI plans to tighten the internal code of conduct of the companies to curtail Insider trading at its very source.
This entire incident demonstrated SEBI’s intention to deal with the cases of Insider trading very seriously and it also sent a very strong message to the company, brokers, analysts etc. That whoever passes a price sensitive or insider information about a company will have to face serious repercussions for the misconduct.
Colocation scam of 2018
In August 2009, the National Stock Exchange gave the facility to brokers to place their service in the NSE premises, primarily in data centre of the premise. The ease of the colocation facility was that it provided quicker access to the buy and sell price to the brokers. Due this being an expensive affair only a limited number of brokers could avail this facility. In this case, after a few months of starting of this facility, there were some brokers particularly OPG securities, who was logging in first and getting the information faster than others stock brokers. This whole system led to wrongly gained advantageous position for some companies. Some of the officials of the exchange were held guilty for purposely favouring some of the brokers group.
Changes happened post the Colocation scam of 2018
SEBI heavily fined the national stock exchange in the colocation scam. The amount of fine was fixed at Rs. 625 crores along with 12% interest. SEBI ordered the amount to be deposited in the Investor Protection and Education Fund. The exchange was also barred for89er accessing the market for launching new product and giving public issue for six months. OPG securities was barred from offering brokerage service for five years and the directors of the company were fined. PIL was also filed in the Delhi High Court by Shantanu Guha Ray, who alleged that NSE has facilitated unfair trade practices. CBI took over the investigation and it was concluded that the NSE was engaged in unfair practices and gave preferential treatment to a particular broking firm over others.
Karvy Stock broking scandal 2019
The digitalised trading and broking have opened the gateways to many scandals. Wherein, the entities get indulged in unfair trade practices and take the plea of technical issues. Such was the case in the recent Karvy stock broking scandal. Karvy is a conglomerate providing the business of wide variety of financial services to over millions of individual investors and several corporates.Karvy stock broking limited the part of karvy group was recently involved in a controversy. In 2019, the company was prohibited by SEBI from taking new clients.
Karvy’s was suspected by SEBI when it took longer than usual to return the amount owed to the investors. Normally the course of transaction takes three working days. But many investors complain that they broker took more than a week to return the money. It was then the watch dog noticed the flags. The broker took the plea of technical faults in the system. SEBI and NSE investigated the matter and it surfaced that Karvy was misusing the client’s securities. Karvy pledged the client’s securities into its own trading account. Misappropriation of funds of Rs.1096 crore was done by them to finance another arm of the conglomerate Karvy realty.
Karvy pledged the clients’ securities to Banking companies like ICICI, Bajaj Finance etc. claiming the securities to be its own. This is breach of trust of not only the banking entity but also the investors. Among the affected group of investors, the depository returned the money of most investors. Karvy’ s stock broking licence was cancelled by both National stock exchange and Bombay stock exchange.
Kravy appealed against NSE’s order of suspension from trading in the Securities Appellant Tribunal (SAT) and also against SEBI, which has banned the Kravy to function as Broker in the market.The Tribunal however, dismissed both complaints filed by Kravy. And the duty to return the investors their amount has been given to the investor grievance cell of the stock exchange.
Changes happened post the Kravy Scam
The regulator has become stricter with its approach towards the online brokers and through constant vigilance keeps in check their code of conduct. India being an ever-growing economy has both potential and growth and a lot of credit for that goes to the rapid expansion of the capital market. But the financial frauds and scams act as a barrier towards the accelerated rate of growth the market that it is capable of doing.
Over the years, the nature of financial frauds in the capital market has evolved. Be it trading through the physical or digital mode. The wrongdoers always find a way to commit a fraud using various securities of the capital market from stocks, schemes or mutual funds. The regulators and the government have always tried to take steps with regard to investor protection and redressal. With every scandal of the capital market the face of corporate governance and security law in India has evolved.
It is not just the regulators and investors who are worried and greatly affected by the corporate frauds but also the companies who are conducting the business by the book and it is very important for them to have investors in the market and a liberal approach of the market regulators towards their functioning. The various corporate houses in order to understand the concerns of the investors indulge into data collection by survey method. The subjects to these surveys are mostly the investors and fellow corporate houses. For example: Earnst and young in 2006, conducted a survey in which it found out that the companies admit that the level of frauds have significantly increased due to lack of internal audit. KPMG also conducted a similar survey where it was indicated by the investors that telecom, software, retail, banking, mutual funds among others are one of the most vulnerable sectors and prone to frauds. Sound Corporate governance, transparency and accountability is very much required for the overall growth of the economy.
Avantika Banerjee is Assistant Professor of Law at Law College, Durgapur. She teaches Taxation, Merger& Acquisition, Banking law and Security Law. She is the Co-founder of Indian Society for Legal Research and practices at Debt Recovery Tribunal, Kolkata. She has practiced at National Company Law Tribunal, Allahabad (Prayagraj).
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