During 1991, India had just completed its economic reforms. Indian laws had started being more flexible towards private banks and foreign banks. This led to increasing competition to public banks which anyways having their own challenges to maintain profitability and statutory reserve ratios.

To maintain the Statutory Reserve Ratios (SLR), Banks were required to invest in govt bonds. Banks wanted to invest in these Government Bonds. with ease as well as wanted to maintain their profitability. For doing so, public banks took the help of brokers like Harshad Mehta.

These brokers used to bring in deals for them for buying and selling government securities at the best possible price. To get the best rates for government securities, brokers used to ask banks to issue cheque in their name and used to ask for a time of up to 15-20 days to get the securities. During these 15 days, money taken from the bank was being invested in the Stock Market which was absolutely illegal and unethical too. These brokers used to make a substantial profit from this and one part of this profit was being provided to banks in name of Bankerage, which helped them maintain profitability.

Mr. Mehta is also said to get fake Bank receipts (G Bonds) issued from a few public sector banks and sell them to other banks.

Now Let’s make our Study Material interesting by linking with our CFA Ethics Standards and let’s see which standards were violated:

CFA Ethics standard I (a) Knowledge of law It can be reasonably said that Mr. Mehta had absolute knowledge of the law and he knew that practices like insider trading and using bank’s money for manipulating share prices is completely illegal. He observed that other people are doing it and getting away with it.

CFA Ethics Standard I(A) Knowledge of law clearly mentions that if you see someone violating the law, you should confront that person and try your best to stop illegal activity. Here Harshad Mehta seems to have done exactly the opposite. Instead of making efforts to stop illegal activities, he decided to join the club.

CFA Ethics standard II(A) Material Non-Public Information: It is said that Mr. Mehta used to get critical inside news about some stocks like Sterlite Industries. Actually, it is believed that he made contracts with company officials to get the inside information which he used it to make significant profits. It’s a clear violation of CFA Ethics standard II(A) – Trading based on Material Non-Public Information:

CFA Ethics Standard II(B) Market Manipulation It is said that Harshad Mehta managed to boost up shares of a few companies like ACC, Polo, etc by a crazy percentage of 4400%, and then sold his personal shares at significant profits. It’s a prominent example of a violation of CFA Ethics Standard II(B) Market Manipulation where both price and volume were being manipulated.

CFA Ethics Standard 1 (C) Misrepresentation Growmore Investment (Portfolio management firm of Harshad Mehta) was said to guarantee a specific return to its clients when in fact securities where client’s money was invested did not have an explicit guarantee from government bodies or financial Institutions. This action violates CFA Ethics Standard 1 (C) Misrepresentation.

CFA Ethics Standard III (C) Suitability In an effort to win against Bear Cartel, Harshad Mehta is said to have purchased shares of few companies in the portfolio of clients where he was manipulating prices without making an effort to see if those shares were truly suitable or not for the client’s portfolio. This action violates of CFA Ethics Standard III(C)- Suitability.

CFA Ethics Standard V (C) Record Retention In an effort to escape from income tax penalties, it is said that many records were hidden or destroyed by Growmore Investment. It’s a violation of CFA Ethics Standard V (C)- Record Retention.

CFA Ethics Standard IV (C) Responsibilities of Supervisors: It can be reasonably said that RBI didn’t act as a responsible supervisor of the banking industry and failed to detect this illegal practice of the Bank’s (and hence the common man’s) money getting pumped into the Share Market.

CFA Ethics Standard 1(D) Misconduct The basic policy of using Bank’s Money for trading in the Stock market was (and still is) illegal. Further actions like Price and Volume manipulations is clear evidence of Fraud which violates CFA Ethics Standard 1(D)- Misconduct

Hold On, we can also relate this Scam to our Equity Investments subject. Keep Reading

As Harshad Mehta was able to derive significant profit from insider trading, it can be concluded that the market in 1992 was an informationally inefficient market (CFA Equity)

Herding — Investors were absolutely reliant on Harshad Mehta’s intuition (quite evident as he was called as Bachchan of Stock Market) and followed his advice blindly without even looking after the financials or without analyzing fundamentals of the stock of a company and blindly made their positions.