The Securities Fraud That Transformed Indian Financial Law

Author: Abhinav Mishra, a student at Faculty of Law, Banaras Hindu University

To the Point

The landmark case of SEBI v. Harshad Shantilal Mehta remains a turning point in India’s financial and legal history. In the early 1990s, Harshad Mehta, a high-profile stockbroker dubbed the “Big Bull,” executed a series of complex financial manoeuvres that shook the foundation of India’s stock market. He manipulated the equity market by exploiting deep-seated regulatory and systemic inefficiencies within the banking sector. By utilizing flaws in interbank securities transactions—particularly those lacking transparency and real-time oversight—Mehta redirected large sums from banks under false pretences.

The funds, often obtained through fictitious or unauthorized banking instruments, were used to purchase stocks in massive volumes, inflating share prices to artificial highs. This created a misleading picture of a bullish market driven by supposed economic confidence. At its peak, the scam involved over ₹4,000 crore, stunning the country and leading to severe market volatility. The exposure of this fraud catalyzed sweeping reforms in India’s financial architecture, from the introduction of digital trading platforms to the establishment of robust regulatory checks by institutions like SEBI and RBI.

Use of Legal Jargon

The legal landscape surrounding the Harshad Mehta securities scam was vast and complex, involving a host of statutory and regulatory frameworks. The charges levelled against Mehta and his associates covered criminal law, banking fraud, securities manipulation, and violations of fiduciary duties. The primary legal accusations included:

• Section 120B of the Indian Penal Code (IPC): Pertaining to criminal conspiracy
• Section 420 IPC: Dealing with cheating and dishonestly inducing delivery of property
• Sections 467, 468, 471 IPC: Addressing forgery, using forged documents, and intent to defraud

The Prevention of Corruption Act, 1988 was invoked due to the involvement of public sector bank officials who either facilitated or failed to prevent the diversion of public funds. These officials were alleged to have accepted fake Bank Receipts (BRs) or overlooked irregularities in Ready Forward (RF) deals.

From a regulatory standpoint, several acts came under scrutiny:

• SEBI Act, 1992: For breaches in market integrity and disclosure norms
• Reserve Bank of India Act: For misuse of banking systems and instruments
• Banking Regulation Act, 1949: To address failure of internal controls and oversight
• Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992 (TORTS Act): Enacted specifically to expedite trial of cases arising from this fraud

Several key legal doctrines were applied during prosecution and civil proceedings. These included:

• Fiduciary duty: Emphasizing the obligation of banks and financial institutions to act in good faith
• Constructive trust: Wherein the misused funds were legally considered as held in trust for the defrauded institutions
• Unjust enrichment: As Mehta profited unlawfully from public money, restitution became central to the legal remedy
• Misrepresentation: Highlighting the deceptive nature of financial statements and BRs used in the scam

The scam redefined how white-collar crimes were approached in India, leading to a more sophisticated understanding of financial jurisprudence in judicial circles.

The Proof

The mechanics of the scam were ingeniously deceptive and relied heavily on loopholes in how banks managed interbank transactions. At the heart of Mehta’s operations were Ready Forward (RF) deals and Bank Receipts (BRs)—legitimate financial instruments in concept, but highly vulnerable to misuse in the absence of standardized oversight.

Ready Forward deals function as a form of short-term borrowing where one bank sells government securities to another with an agreement to repurchase them after a certain period. Ideally, these deals are backed by actual government securities. However, Mehta would bypass this by either not delivering the securities or using fake BRs—documents that falsely confirmed ownership or sale of securities.

In collaboration with cooperative banks and select public sector banks, Mehta orchestrated a network of bogus transactions. The participating banks often did not verify the securities against which funds were being lent. Through these fraudulent instruments, Mehta siphoned funds from reputable banks such as State Bank of India and UCO Bank. These funds were then invested in the equity market, driving up prices of targeted stocks such as ACC, Sterlite Industries, and Videocon.

The inflated prices attracted retail and institutional investors, further driving up the valuation. Mehta would then exit these stocks at a profit, leaving the banking system exposed when the fake BRs were discovered to have no underlying assets. The scam, at its height, accounted for nearly 30% of daily market turnover.

The fraud began to unravel when Sucheta Dalal, an investigative journalist with The Times of India, published a detailed exposé on April 23, 1992. Her story highlighted Mehta’s manipulation of the banking system and triggered a domino effect of investigations. Agencies such as the Central Bureau of Investigation (CBI), Securities and Exchange Board of India (SEBI), Reserve Bank of India (RBI), and a Joint Parliamentary Committee (JPC) initiated probes. These investigations revealed a deeply entrenched nexus involving stockbrokers, bankers, politicians, and business entities.

Abstract

The Harshad Mehta securities scam of 1992 is more than a tale of individual misconduct—it is a case study in systemic failure, regulatory oversight collapse, and the urgent need for institutional reform. India had only recently opened up its economy, and the financial system was struggling to keep pace with liberalization. The scam demonstrated how inadequate regulation, manual record-keeping, and lack of inter-agency coordination could be exploited to defraud the system on an unprecedented scale.

The judicial response included the establishment of a Special Court through the TORTS Act, aimed at providing speedy trials for economic offences. Over the next decade, multiple court judgments clarified the liability of financial institutions, the hierarchy of creditor claims, and the responsibilities of market regulators. The case also served as a launching pad for a series of legislative reforms including:

• Enhanced SEBI powers to oversee and regulate market participants
• Legal framework for the dematerialisation of shares
• Mandatory disclosure norms for listed companies
• Formation of investor grievance redressal mechanisms
• Establishment of clearing corporations for settlement of trades

The scam altered public perception of the stock market, introducing caution and the demand for better investor protection. It pushed India to adopt global best practices in securities regulation and corporate governance.

Case Laws

1. State Bank of India v. Harshad Mehta
   This case focused on the retrieval of funds that were misappropriated by Mehta. The judgment emphasized the rights of public sector banks and recognized the powers of the Special Court to issue directives for asset recovery from Mehta’s estate. It became a precedent in determining how financial institutions can claim compensation in fraud cases.
2. SEBI v. Harshad Mehta
   SEBI initiated several enforcement proceedings against Mehta, resulting in lifetime trading bans, hefty financial penalties, and a bar from participating in the capital markets. The rulings clarified the scope of SEBI’s civil and regulatory jurisdiction, especially concerning fraud, misrepresentation, and insider trading.
3. Harshad Mehta v. Custodian
   This legal battle helped establish the powers vested in the Custodian appointed under the TORTS Act. The Custodian was empowered to take possession of Mehta’s movable and immovable properties—including stocks, bonds, and real estate—to settle liabilities towards defrauded banks and financial institutions.
4. Canara Bank Financial Services Ltd. v. Custodian
   This Supreme Court ruling set a significant precedent by upholding that institutional claims from banks and financial entities would override personal or third-party claims against the assets of the accused. This reinforced the principle that public funds must be restored before satisfying any private debts.

Conclusion

The SEBI v. Harshad Mehta case was a defining moment for India’s financial ecosystem. It laid bare the vulnerabilities in banking practices, regulatory inefficiencies, and the lack of technological safeguards. What began as a confidence scam grew into a full-scale crisis, revealing how unchecked market manipulation could jeopardize national economic stability.

The long-term impact of the scam included:

• Establishment of National Stock Exchange (NSE) in 1994 with a fully automated trading system
• Technological modernization of the Bombay Stock Exchange (BSE)
• Mandatory online trading, replacing the manual “open outcry” system
• Introduction of T+2 settlement cycles
• Mandatory audit trails and surveillance on stock transactions
• Empowerment of SEBI with quasi-judicial powers and rule-making authority

Moreover, the scam catalysed a cultural shift—investors began demanding transparency, accountability, and ethical conduct from market players. Financial journalism gained prominence, and legal literacy about investment and fraud prevention began to spread among the general public.

While Harshad Mehta’s actions caused significant financial losses, the legal and institutional legacy that emerged created a more resilient, tech-enabled, and globally aligned Indian financial system.

FAQ

Q1: What were the main allegations against Harshad Mehta?
A1: He was accused of using forged bank receipts and unauthorized transactions to misappropriate funds from Indian banks, which were then used to manipulate stock prices.

Q2: Which legal provisions were applied in the case?
A2: The primary statutes invoked included Sections 120B, 420, 467, 468, and 471 of the Indian Penal Code; the Prevention of Corruption Act, 1988; the SEBI Act, 1992; the Reserve Bank of India Act; and the Special Court (TORTS) Act, 1992.

Q3: What was SEBI’s involvement?
A3: SEBI played a pivotal role in investigating the scam, imposing civil penalties, banning Mehta from stock trading, and recommending market-wide regulatory reforms.

Q4: What was the final outcome of the case?
A4: Harshad Mehta was arrested and faced multiple criminal and civil charges. He died in 2001 while in judicial custody. His assets were subsequently seized and sold under the supervision of a court-appointed Custodian to compensate the affected banks and financial institutions.

Q5: What long-term changes did the scam lead to?
A5: The scam led to institutional and legal transformations including the founding of the NSE, digitization of stock trading, SEBI’s regulatory strengthening, better fraud detection systems, and tighter financial norms across India’s capital markets.