Author: Amisha Nair, Amity University, Noida
To the Point
The Harshad Mehta securities scam of 1992 was a watershed moment in India’s financial history. It revealed systemic loopholes in the banking sector, highlighted the absence of a strong regulatory framework, and demonstrated how one man exploited the inefficiencies of the system to manipulate the stock market. The aftermath of this scam not only led to criminal prosecutions but also transformed India’s securities law regime, paving the way for stronger oversight by the Securities and Exchange Board of India (SEBI).
Abstract
The 1992 securities scam orchestrated by Harshad Mehta was not merely a financial manipulation but a legal milestone in India’s corporate jurisprudence. It showcased the interplay between banking law, securities regulation, and criminal law. The scandal brought to light deficiencies in statutory mechanisms, particularly the absence of a robust regulatory watchdog with teeth. Subsequent legal reforms, including amendments to the SEBI Act, 1992, and the strengthening of the Depositories Act, 1996, were direct consequences of the scam. This article evaluates the scam from a legal perspective, examining statutory violations, judicial responses, and its long-lasting impact on Indian financial regulation.
Use of Legal Jargon
The Harshad Mehta scam, from a legal standpoint, epitomizes the complexities of white-collar crime where financial ingenuity intersected with systemic loopholes. At its core, the scam involved criminal breach of trust under Section 405 IPC, as funds entrusted for inter-bank transactions were misappropriated and diverted into the stock market, thereby violating the fiduciary duty of banks. The fabrication and circulation of Bank Receipts (BRs), which had no underlying securities, attracted liability for cheating under Section 420 IPC, while also constituting forgery of valuable securities under Sections 467 to 471 IPC. The entire scheme reflected a calculated mens rea, which in economic offences is often inferred from circumstantial evidence and patterns of fraudulent behavior.
The involvement of multiple shell companies further necessitated the doctrine of lifting the corporate veil, as these entities were mere alter egos of Harshad Mehta, established to camouflage illicit activities. Legally, the manipulation of stock prices through circular trading and artificial demand creation constituted a clear violation of the Securities Contracts (Regulation) Act, 1956, which prohibits unfair and fraudulent trade practices.
Additionally, the scam exposed systemic weaknesses in the inter-bank settlement system, amounting to breaches of the Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949, where bankers acted in an ultra vires manner by issuing BRs without legitimate backing.
The criminal liability of public sector bankers extended to charges under the Prevention of Corruption Act, 1988, as collusion and acceptance of illegal gratification facilitated the fraudulent transactions. Their acts also attracted liability for abetment under Sections 107 to 109 IPC, as they actively enabled the execution of the fraud. From a broader jurisprudential lens, the scam invoked the public trust doctrine, as banks hold deposits in trust for the public and any breach of this duty is not merely contractual but an affront to public confidence in financial institutions. Moreover, though the Prevention of Money Laundering Act, 2002 (PMLA) was enacted much later, the scam highlighted the pressing need to criminalize the process of converting illicit gains into seemingly legitimate assets.
Finally, the scandal served as a turning point in securities regulation, leading to the strengthening of the Securities and Exchange Board of India (SEBI) Act, 1992, particularly Section 11, which empowered SEBI to prevent fraudulent and unfair trade practices in the securities market. The doctrine of investor protection, a cornerstone of securities law, was invoked repeatedly by courts and policymakers, emphasizing that capital markets must operate under the principles of fairness, transparency, and accountability.
The Proof
Harshad Mehta, a stockbroker, exploited the inter-bank lending system by obtaining unsecured loans from banks against fake or forged Bank Receipts.
Funds obtained through this route were invested in shares of companies such as ACC, Sterlite, and Videocon, artificially inflating stock prices by more than 4000% in some cases.
The Reserve Bank of India (RBI) later found discrepancies amounting to nearly ₹4,000 crores.
Investigations by the Joint Parliamentary Committee (JPC) and SEBI exposed how regulatory gaps facilitated the scam.
Case Laws
1. Harshad S. Mehta v. Central Bureau of Investigation (1992–2001)
Multiple criminal cases were filed against Mehta under IPC provisions and the Prevention of Corruption Act, 1988.The Bombay High Court and later the Supreme Court dealt extensively with bail petitions and asset seizures.
2. Radhasoami Satsang v. CIT (1992) 193 ITR 321 (SC) – Though unrelated directly, this case was cited in tax litigation involving Harshad Mehta’s firms, addressing the question of income recognition and fraudulent concealment.
3. CBI v. Harshad Mehta & Ors. (Special Court, 1999) In this case it was established that fake BRs amounted to forgery and criminal conspiracy under IPC. Reinforced that bankers who colluded were equally liable under abetment provisions.
4. Union of India v. SEBI (1997) – This case emphasized SEBI’s powers to regulate brokers and curb manipulative trade practices, directly emanating from the lessons of the scam.
5. N. Narayanan v. Adjudicating Officer, SEBI (2013) 12 SCC 152 The Supreme Court, while dealing with insider trading, reflected upon the Harshad Mehta scam as an example of why corporate governance and investor protection require stringent enforcement.
Conclusion
The Harshad Mehta scam was a catalyst for reform. While it tarnished the credibility of India’s stock markets in the early 1990s, it also triggered legal, regulatory, and institutional changes that strengthened financial governance. The scam underscored the need for transparency in securities transactions, stricter banking norms, and enhanced powers of SEBI. Legally, it reaffirmed that white-collar crimes, despite their complexity, fall squarely within the ambit of criminal liability. The legacy of this scandal lies not only in the fall of a financial giant but in the rise of a stronger legal and regulatory framework in India.
FAQS
Q1: Which laws were primarily violated in the Harshad Mehta scam?
The Harshad Mehta Scam has violated the Indian Penal Code, the Reserve Bank of India Act, the Banking Regulation Act and The Securities Contracts (Regulation) Act.
Q2: Did SEBI exist before the scam?
Yes, SEBI was established in 1988, but it lacked statutory powers. It was only after the scam that SEBI Act, 1992 gave it real authority.
Q3: How did the scam affect the Indian stock market?
The scam triggered a massive crash in stock prices, eroding investor wealth and shaking confidence in the financial system. It exposed the fragility of market mechanisms and revealed how unchecked broker practices could destabilize the entire economy.
Q4: What happened to Harshad Mehta legally?
He faced more than 70 criminal cases, including charges of cheating and forgery. He was convicted in some but died in custody in 2001 while trials were still pending.
Q5: What reforms came after the scam?
Strengthening of SEBI, creation of the National Stock Exchange (NSE) for transparent trading, introduction of online settlement systems, and tighter banking regulations.
