How to manage external crisis that brings changes

Two major Stock market crises in India that shook investor confidence.

 Organizational Change Management

Any Crisis can always expose system  disorder and deficiencies while it can trigger  changes in the system and organizations. Yet regulators fail to learn from disruptive disasters despite huge negative experiences. Such is the case with Indian Stock Market Regulatory System. From fake bankers' receipts to warehouse receipts, from Bull’s manipulation of Bombay stock Exchange or National Stock Exchange, many events happened but no drastic preventive  step seems to have been taken done much with India’s financial control systems but for  few cosmetic changes in reporting and compliance standards

Here is how few of these big-time frauds were perpetrated. 

Not many fraudsters can boast of inspiring  Bollywood producers to make blockbuster movies  but Harshad Mehta's life inspired many film stories including one called Gafla- which means Fraud-were made on one man's life Harshad Mehta, who was a high-profile stockbroker.The news about him hit the media headlines with  the most talked about and notorious Bombay Stock Exchange security scam of 1992 and was charged with 27 cases and later convicted for only 4   faced untimely death at the age of 47.Living lavishly and accumulating wealth quickly Mehta  was quickly in the power elite club.

In India, the Gujarati Jain community  is known to be shrewd  in business and BSE had a fair share of dominant share brokers from this community. The community support for each other is very intense. Mehta grew up in  Mumbai the commercial capital of India where his father was a small-time businessman and with  media push he managed his won  transformation from a small-time broker to big time player and was  nicknamed as ‘Big Bull’. Mehta had  a brief stint on a job with a general insurance company and later changed track to a BSE affiliated stockbroker, going on to become a jobber on the BSE for another leading stockbroker and soon became a sub-broker for leading stockbrokers.

With  experience as a sub-broker to dabble in equity shares, he joined hands  with his brother to float a new company  called Grow More Research and Asset Management Company Limited. By the year 1990, Mehta’s   name in the Indian stock market came to be  associated with bull runs. He used to buy  heavily the shares of blue chip cement company (ACC) and the tactics were  mainly to exploit the strong investor confidence in that script. He could  artificially inflate the price of the company's  share to the extent of a 4400% jump in its price. By 1991, Mehta had  risen to be  the big player and the media propelled  him to get into that orbit.

Once again the power elite was in full force. The huge scam  was blindly supported and helped by Mehta’sclose-knit associates, community members, bank-chiefs thereby empowering large-scale manipulation of shares in the Bombay Stock Exchange and  exploit the loopholes in the Indian banking system to siphon  off funds . Once huge cash was  at the disposal,  shares at a premium across many industry verticals were bought in large volume causing the Sensex to flare up dramatically. Few of the banks who lent money smelt Mehta’s intentions and , they started to demand the money back amounting  to billions of rupees, and once this news leaked to  the press  the Sensex to collapsed dramatically. This crisis impacted many financial companies and investors lost money for no fault of theirs. Mehta was charged with 72 criminal offenses and over 600 civil action suits were filed against him. Mehta’s illegal methods of manipulating the stock market got exposed in April 1992 not by any government or regulatory agencies but by the financial columnist for The Times of India, the leading daily newspaper. 

Stock market scam 2- Bombay Stock Exchange -India

Ketan Parekh was a chartered accountant -Indian equivalent of American CFA-by profession and a stockbroker based in Mumbai, India. He ended up as a convict in 2008 for engineering the largest scam in technology stocks in India’s stock market in 1999-2001. Parekh grew up in a family of stockbrokers and ended up serving a period of disqualification from trading in the Indian bourses till 2017.

Ketan Parekh created another scam and was helped by media hype. A media-shy person was projected as sharpest share market predictor as he was known to have razor-sharp forecasts on market developments. Harshad Mehta and Ketan Parekh have committed  the frauds using similar means and their backgrounds were similar. Mehta came from a lower middle-class with a modest background, while KP’s family was engaged as stockbrokers for a significant time and was also related to many prominent stockbrokers. Secondly, when Mehta was operating, the market was still a closed one and was just beginning to liberalize. Mehta operated using the money of other people; Mehta was known to have resorted to aggressive publicity campaigns whereas KP was media shy initially and operated almost clandestinely. Ketan was also successful in planting stories and selling them aggressively to institutional investors. Parekh was watched closely by all other  market players and they kept track of every move of Parekh.Everything he touched was getting big time profits. The "Pentafour Bull" as he came to be known kept always a low profile.

By 1999-2000, Indian IT companies started growing and were to go public.These stocks would eventually be the golden goose and were to start showing signs of hyperactivity as well. Parekh targeted few of these IT companies to push the prices up. Almost everyone, from investment firms which were mostly controlled by promoters of listed companies to foreign corporate bodies and cooperative banks, was eager to entrust their money with Parekh, which, in turn, was used to artificially inflate stock prices.

Once Parekh’s touch in a stock was evident, stock prices saw upward spiral .As an example, the shares of  Visual soft rose from IRS 625 to IRS .8448 per unit, while those of Sonata Software went up from IRs 90 to IRS 2,150. These IT companies had no worthwhile track record.Mere price rigging was not the end and the artificially inflated stocks had to be  dumped somewhere  and Parekh found a safe place in few financial institutions such as the Unit Trust of India. It is not unusual industry practice in India for companies issuing IPO to take the help of stock brokers to back the issues and rigging the post issue prices KP had formed a network of brokers from especially from smaller cities such as the Allahabad Stock Exchange and the Calcutta Stock Exchange who would do the price manipulation.

In India, a transaction is called benami (translates to ‘nameless’ or without a name ) when the consideration for a deal especially property that is transferred to a person or is held by him/her is paid by another person. In such transactions, the person who pays for the property is the ultimate beneficiary of the property directly or indirectly, at  the future date . Such a property is considered benami, People used this method to launder unaccounted cash  or hide ill-gotten wealth through unlawful means.This is also a channel used to do tax evasionThe government made this illegal under the Benami Transaction (Prohibition) Amendment Bill, 2015 to try and stop money laundering frauds

‘Benami’ (doing business in dummy or proxy   name) was used by Parekh to purchase stocks in the names of poor people living in Mumbai’s slums. Using personal influence KP also borrowed huge sums from a private bank -Global Trust Bank and profited significantly through price manipulation. While the actual loan amount from Global Trust Bank was reportedly IRS. 2.5 billion, while the bank asserted that Parekh had received less than IRS. 1.00 billion and that too in keeping with RBI norms. A loan of IRS. 10 billion was given by another small size community bank- Madhavpura Mercantile Cooperative Bank and that was clear violation of RBI regulations on maximum amount a broker could get (IRs 150-million). A bear cartel finally brought down and crushed the flaring prices in February 2000. Desperate attempts of KP and his allies to prop up the prices could not rescue falling prices. The banks who were involved viz The Global Trust Bank and the Madhavpura Cooperative was driven to bankruptcy because  the money they loaned  went bad and became bad debt  overnight.

The crime investigating agency in India, the Central Bureau of Investigation (CBI) finally halted Ketan Parekh’s two-year dominance of the share market by arresting him on complaint of a leading government bank ,Bank of India (BOI). Just as in the case of fraudulent dealings by Nick Leeson of Barings bank, Parekh also had to meet his downfall because of the high risks and exposure. This crisis did huge damage to the image of Bombay stock exchange and destroyed the trust and confidence of millions of investors especially the amateur investors who blindly followed Ketan Parekh. When the scam burst, the inflated shares lost their values so heavily, that quite a few people lost entire lives the savings. Few banks including small government owned banks also lost significant amounts of money. Parekh's plot was not comprehensible to any lay investor. Media was the culprit to fuel a positive image of him like a Bollywood movie hero. Few national dailies had even interviewed and quoted him profusely as an expert even on government India’s Union Budget.

The white collar criminals are always one step ahead of the systems that try to prevent the crime. Harshad Mehta’s scam of 1992 exposed the miserable inadequacy of the regulatory system and the subsequent Ketan Parekh's fraud reinforced the inadequacy. The Securities Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) failed to plug the inadequacy of the control systems and they could not come up with any proactive steps. Few steps taken were like band aid solutions

The trading cycle was cut short from a week to a day. The carry-forward system in stock trading called ‘BADLA’ was banned. SEBI formally introduced forward trading in the form of exchange-traded derivatives to ensure a well-regulated futures market. It did away with stock broker control over stock exchanges. In KP’s case, the price rigging of the shares were known to Dalal street operators. Financial institutions such as Industrial Development Bank of India (IDBI Bank) and Industrial Finance Corporation of India (IFCI) bent backwards to grant loans to the tune of IRS. 1.4 billion to companies known to be close to Parekh thereby fueling the crisis.

Effective crisis management plan from SEBI was absent and they were clueless about its preventive responsibilities. There was a misplaced perception of their  role to be a watchdog to monitor stock prices than being responsible for fraud prevention. SEBI brought in some changes and took few extreme measures and banned short sales and increased margins which only led to a virtually cash-starved market and shrinking turnover to one-sixth of the normal level.It also fired all broker directors from the Bombay Stock Exchange and Calcutta Stock Exchange.

Though SEBI took steps against the bear operators and launched an inquiry into their alleged short the sales the extent it discouraged others was minimal . The crisis triggered changes in the way business was done in  India’s stock markets  and made it bit safer and in restoring investors' confidence to some degree. The crisis  was the single factor in forcing inefficient policy-makers to bring about reforms in the financial system.

As penalty banning few offenders  and entities from trading in the stock markets does not seem to be effective.Such bans matter little as the banned players know how to beat the system and work around. Enforcing the ban is far more difficult than handing out the punishment. InInida one can start a private limited company,appoint some relative or close acquaintance as a director, and invest through that firm without drawing attention.

The moral of these crises and  events is that changes come when crises affect the system only to  reoccur when some intelligent person exploits the system's loophole