In recent times, we have witnessed that the stock market is growing steadily, and investors are participating in the upcoming IPOs, also in the secondary market, to earn additional income besides regular ones. But isn’t it interesting to know what the stock market has reinforced since ancient times?

In the late 90s, the market was almost on the verge of decline due to the 1992 Indian Market Scam that had changed the entire capital market system. The stock market scam occurs when brokers, dealers, insiders, and traders trick others into buying shares at unreasonable prices against investors. There could be many reasons behind every scam that occurred as it had defined distinctly compared to earlier.

There are also different types of stock market frauds that have happened in the past. Because of various scams, the entire market was affected by depression, and the Indian economy was badly losing its graph. After the huge loss in the capital market, major reforms were introduced to avoid and recover the market back to its peak. 

Types of Stock Market Frauds

Securities Fraud occurs when a party buys, sells, and trades securities illegally. It also includes providing false information about the share price, leaking confidential information about the company, corrupting top officials of the firm or banks, selling shares at high prices, incorrect guidance by the brokers about the stocks, etc. Let’s know more about various Stock Market Frauds in the Indian Stock Market.

1.      Shell Companies

These companies are set up to hide and protect the company’s overall assets and illegal income earned to prove the company’s dignity in front of legal authorities. These companies often play an essential role in storing black money or illegally earned income.

The criminals use these companies at times of money laundering, evading taxes and conducting all forms of fraud. It is called a shell corporation as it does not have active business operations or significant assets. Despite this, the Modi Government had banned nearly 4 lakh shell companies all over India as per ROC records. 

2.      Insider Trading

It refers to trading a public company’s stock or other securities like bonds, etc., based on material, non-public information of the company. When an individual uses this confidential information illegally to buy or sell stocks and manipulate stock prices, insider trading frauds are considered. Thus, this practice is prohibited by the Companies Act, 2013 and the SEBI Act, 1992. 

3.      Financial Statement Fraud

Accounting fraud intentionally manipulates financial statements to hide the company’s revenue system. If the company had earned a high income for a particular financial year, it would show less revenue in its financial statements and vice-versa. Thus, financial statements that are thoroughly audited and certified are meant to be trustworthy. 

Along with this, many such frauds occurred in the past. They are as follows:

• Pumps and dumps.
• High yield investment fraud.
• Advance fee fraud.
• Third-Party misinterpretation.
• Promissory notes.
• Ponzi and pyramid schemes.

Historical scams of the stock market

The 1992 Indian Stock Market Scam: Harshad Mehta Scam

This unexpected scam is considered one of India’s biggest money market scams that changed the entire outline of the capital market. Stockbroker Harshad Mehta committed it. The scammer was born in PaneliMoti of Rajkot District, brought up in Borivali, and later graduated from LalaLajpatrai College, Bombay. He was involved in the 1992 Indian stock market scam and other corrupt bankers and politicians cropped up in the Bombay Stock Exchange. The scam amounted to Rs 5000 crore.

The techniques he used were firstly contacting corrupt officials and politicians, signing a fake cheque, misusing market loopholes, driving the stock prices up to 40 times their original prices, etc. This helped the corrupted officials secure unsecured approved loans from the bank fraudulently and earn maximum returns. The scammer had an intellectual mindset and was ready with a systematic plan in his focused mind at every stage of his life. The scope of the scam was so large that the net value of stocks was higher than India’s combined health and education budget. He made the stock prices soar high through fictitious practices and later sold the owned stocks of the companies. 

His primary pillars of a scam include stamp paper and bank receipts that caused an actual crash in the capital market. He cleverly compromised with the bank officials for the money he wanted to invest in stocks to get it transferred to his personal bank account by promising them to pay the entire loan back with high-interest rates.

Mehta used the money banks transferred to buy the shares to increase the demand in the market for that particular share. Another such instrument was Bank receipts. In this, the seller of securities gave a BR (Bank receipt) to the buyer of securities. This receipt indicates a promise that the buyer will receive the securities they have paid for. But, the Mehta mindset was unique; he listed out the banks that provide fake BRs or the BRs that are not backed by government securities. Thus, these fake BRs were given to other banks to lend money under the impression that they were lending against government securities, but in reality, this was not the genuine case.

The received amount was invested in the stock market to increase the price of ACC Company from Rs 200 to Rs 9000, thus increasing by 4400%. When these shares were sold in the market, the stock market crashed badly. As a result, the BSE Sensex rose from the 2000- mark in January to 4000-mark in March 1992. After the scam came to light, the tax department conducted a raid at Mehta’s house in February 1992, and several documents and certificates were seized. The tax return filed by Harshad Mehta for the assessment year 1992-93 was rejected, and he was imprisoned in 1992. He passed away at the age of 47 when he was in jail due to cardiac arrest. 

Ketan Parekh Scam

The Ketan Parekh scam was the second most surprising that changed the history of the Indian Capital market after the Harshad Mehta Scam. He was a stockbroker involved in the 2008 Indian Stock Market Manipulation. He had rigged the prices of chosen securities called K-10 companies by borrowing large amounts from banks.

He created another unique mindset by purchasing large stakes from less known small-cap companies and then hiked their prices from circular trading with other traders. For example, Zee telefilms zoomed up share price from Rs 127 to Rs 10000 and many companies like Visualsoft, Sonata Software, etc. This set of 10 stocks was known as K-10 companies, and Ketan Parekh was referred to as Pentafour. He accepted money from large promoters, industrialists, and Madhavapura Mercantile Commercial Bank (MMCB) to grant unsecured loans to the banks.

He had also invested money in Calcutta Stock Exchange (CSE), but he did not trade from his account; he asked other brokers to hold the securities and pay the commission accordingly. Later, Parekh was out of cash, and there was no source left, not even the MMBC, the brokers holding the securities were forced to liquidate the cash.

CBI arrested Ketan Parekh under the fault of Insider Trading. He was convicted of rigging the market and was prohibited from trading in the Bombay Stock Exchange for 15 years, i.e. till 2017. In May 2018, the Bank of Baroda recovered the entire amount of Rs 137 crore from Parekh.

NSE co-location Scam

The NSE co-location scam is a market manipulation at the National Securities Exchange of India, which was alleged by selected players who had obtained market information about the share prices ahead of the rest of the market due to its co-location facilities. These facilities are given to traders with dedicated space and infrastructure such as power supply and bandwidth and were offered to keep the server close to the NSE servers for easy data transfer.

As NSE had multi servers, they got allegations that some brokers got preferential access through the co-location facility at the stock exchange. In this, they did early login and dark fibre, which allows a trader split-second faster access to an exchange’s data feed, which results in huge gains for a trader.

In January 1015, a whistleblower wrote to SEBI alleging that a few brokers were able to log into the NSE systems with better hardware specifications. The unfair access was allowed issues from 2012-to 14 when NSE used to reveal price information through a unicast system. Thus, the concept of insider trading was observed.

It had also said that NSE has allowed non-empanelled Internet Service providers to lay fibre cables on its premises for a few stockbrokers. Besides, SEBI had identified 15 stockbrokers for investigation in the case, including Chitra Ramakrishna and Ravi Narain. They were also asked to disgorge 25% of their salaries drawn during a certain period and prohibited from associating with a listed company, a market infrastructure institution, or any other intermediary for five years. SEBI directed NSE to pay Rs 6.25 billion with an interest rate of 12% (worth 10 billion) and barred the NSE from raising money on the securities market directly or indirectly for six months.

The latest SEBI will bring NSE closer to the end of the case, ongoing since 2016. On Feb 10th 2021, SEBI imposed a one crore penalty on NSE and 25 lakh each on Chitra Ramakrishna and Ravi Narain.

Major Reforms occurred after fraud

1.      Establishment of SEBI, i.e. Securities and Exchange Board of India

It is the regulator of the entire capital market in India. SEBI has given various rules and regulations for the smooth functioning of the securities market, and SEBI will provide the one who does any kind of fraud punishment.

2.      Setting up of Private Mutual Funds

Many private-sector firms are now permitted to start mutual funds to avoid monopolies.

3.      Opening up to foreign Capital

Foreign institutions can now buy shares from private companies and government securities from the Indian stock market.

4.      Access to International Capital Market

The Indian corporate system allowed trading in foreign stocks through American Depository Receipt (ADR) in the USA and Global Depository Receipt (GDR) worldwide except in the USA to raise income in the foreign stocks.

5.      Develop Venture capital funds

Since 1991, economic liberalisation has made it easy to participate in high-risk investment projects and provide medium- and short-term funds to companies that find it difficult to raise funds.

6.      Dematerialisation of the shares

Along with shares, all the securities like debentures and bonds can be traded digitally by opening a Demat account. It is also called a paperless trading system.

Though India had witnessed huge market crashes, it also rapidly gained colossal transformation after some new financial policies. Besides, the dematerialisation of shares had eliminated the risk of bad deliveries, and the concept of Share certificates had ended. Digital securities are traded under the rules and regulations of SEBI.

SEBI’s establishment has kept an eye on all the companies and its next take. After the Harshad Mehta scam, many investors and banks lost their money and were afraid to invest back in the market, but they could do so after many campaigns and public awareness. It is rightly said, “Change is the Law of Life” and a necessity. Hence, after many drastic changes, the investors understood a lot about market fluctuations and their impact on illegalities. So one must invest wisely and under proper consultancy.