An Assignment On

Financial Scams of Stock Market in India

In Stock Exchange & Portfolio Management

Submitted To:Mr. Mayur Patel Faculty

Navnirman Institute of Management

Submission Date:27 December 2010 Class: - T.Y.BBA (sem-6) Submitted By:Group Members
1. Rinkesh Bilimoria 2. Fenil Jariwala 3. Bhavik Jariwala 4. Jiten Rana 5. Pratik Vakharia

Roll No
10 32 70 97 120

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Financial scams

1). What is financial scams?

Financial Scam, also known as stock fraud and investment fraud, is a practice that induces investors to make purchase or sale decisions on the basis of false information, frequently resulting in losses, in violation of the securities laws. Generally speaking, securities fraud consists of deceptive practices in the stock and commodity markets, and occurs when investors are enticed to part with their money based on untrue statements. Securities fraud includes outright theft from investors and misstatements on a public company's financial reports. The term also encompasses a wide range of other actions, including insider trading, front running and other illegal acts on the trading floor of a stock or commodity exchange. According to the RBI, securities fraud includes false information on a company's financial statement and Securities and Exchange Commission (SEC) filings; lying to corporate auditors; insider trading; stock manipulation schemes, and embezzlement by stockbrokers.

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2). Types of Financial Scam: Corporate fraud:Fraud by high level corporate officials became a subject of wide national attention during the early 2000s. It became a problem of such scope that the Bush Administration announced what it described as an "aggressive agenda" against corporate fraud.

Internet fraud:According to Securities and Exchange Commission, criminals engage in pump-and dump schemes, in which false information is spread in chat rooms, forums, internet boards and via email (spamming), with the purpose of causing a dramatic price increase in thinly traded stocks or stocks of shell companies (the "pump").When the price reaches a certain level, criminals immediately sell off their holdings of those stocks (the "dump"), realizing substantial profits before the stock price falls back to its usual low level.

Insider Trading:Insider trading is the trading of a corporation's stock or other security by corporate insiders such as officers, key employees, directors, or holders of more than ten percent of the firm's shares.

Microcap fraud:In microcap fraud, stocks of small companies of under $250 million market capitalization are sold fraudulently to the public. Its prevalence has been estimated to run into the billions of dollars a year.

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 Boiler Rooms:Boiler rooms or boiler houses are stock brokerages that put undue pressure on clients to trade using telesales, usually in pursuit of microcap fraud schemes. Some boiler rooms offer clients transactions fraudulently, such as those with an undisclosed profitable relationship to the brokerage.

Short Selling Abuses:Abusive short selling, including certain types of naked short selling, is also considered securities fraud because they can drive down stock prices. In abusive naked short selling, stock is sold without being borrowed and without any intent to borrow. The practice of spreading false information about stocks, to drive down their prices, is called "short and distort."

3). Case of financial scam:Let us describe the main aspects by taking the cases of stock market frauds: 1) Who are the (potential) felons?

Some with the means to do it can be found among: Top executives of listed firms, Also their accountants / auditors / rating agencies Market / finance professionals (bankers, brokers, analysts, consultants, fund managers), Large shareholders (big hands) Financial (and other) media, Even public institution officials, directly or at least by turning a blind eye.

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2) Why do they do it?

Their purpose can be: To raise or to lower investors' expectations. It creates the hope that stock prices will rise, for the manipulators to sell high, or fall, fro them to buy cheap.

Or, for the same purpose, to sustain those expectations. The trick is to boost, or not to discourage - by using means explained below - the existing bullish or bearish trends.

Or to hide financial problems. When people are desperate, or just greedy, they might be tempted to disguise the truth or to play funny games.

3) How do they do it?

How do they mislead investors? Lying, plainly.

They fool them for example by:

Or more elaborately, building a good story that looks like a truth. And repeating such falsities, until they become familiar and seem true and relevant.

Hiding the truth (lying by omitting some crucial points). Or insisting on some sensational news so as to leave in the shadow more important ones (weak signals...).

Building false impressions, showing red herrings and creating smoke screens, directing people to the wrong path.

4) When do they use their tricks?

Some periods are more prone to market excesses than others. They give more opportunity to manipulate, bait and deceive.

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Here some are the Financial Scammers of Indian Stock Market:1. Harshad Mehta:2. Ketan Parekh:3. Ramalinga Raju:-

1. Harshad Mehta:-

Story of the missing Rs 4,000 crore, Samir K Barua and Jayanth R Varma explain how Harshad Mehta pulled off one of the most audacious scams in the history of the Indian stock market. Harshad Shantilal Mehta was born in a Gujarati Jain family of modest means. His early childhood was spent in Mumbai where his father was a small-time businessman. Later, the family moved to Raipur in Madhya Pradesh after doctors advised his father to move to a drier place on account of his indifferent health. But Raipur could not hold back Mehta for long and he was back in the city after completing his schooling, much against his fathers wishes.

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Mehta first started working as a dispatch clerk in the New India Assurance Company. Over the years, he got interested in the stock markets and along with brother Ashwin, who by then had left his job with the Industrial Credit and Investment Corporation of India, started investing heavily in the stock market. As they learnt the ropes of the trade, they went from boom to bust a couple of times and survived.

Mehta gradually rose to become a stock broker on the Bombay Stock Exchange, who did very well for himself. At his peak, he lived almost like a movie star in a 15,000 square feet house, which had a swimming pool as well as a golf patch. He also had a taste for flashy cars, which ultimately led to his downfall. The year was 1990. Years had gone by and the driving ambitions of a young man in the faceless crowd had been realised. Harshad Mehta was making waves in the stock market. He had been buying shares heavily since the beginning of 1990. The shares which attracted attention were those of Associated Cement Company (ACC). The price of ACC was bid up to Rs 10,000. For those who asked, Mehta had the replacement cost theory as an explanation. The theory basically argues that old companies should be valued on the basis of the amount of money which would be required to create another such company.

Through the second half of 1991, Mehta was the darling of the business media and earned the sobriquet of the Big Bull, who was said to have started the Bull Run. But, where was Mehta getting his endless supply of money from? Nobody had a clue. On April 23, 1992, journalist Sucheta Dalal in a column in The Times of India, exposed the dubious ways of Harshad Metha. The broker was dipping illegally into the banking system to finance his buying. In 1992, when the story about the Rs 600 crore that he had swiped from the State Bank of India came out, it was his visits to the banks headquarters in a flashy Toyota Lexus that was the tip-off. Those days, the Lexus had just been launched in the international market and importing it cost a neat package.

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The crucial mechanism through which the scam was effected was the ready forward (RF) deal. The RF is in essence a secured short-term (typically 15-day) loan from one bank to another. Crudely put, the bank lends against government securities just as a pawnbroker lends against jewellery. The borrowing bank actually sells the securities to the lending bank and buys them back at the end of the period of the loan, typically at a slightly higher price.

A typical ready forward deal involved two banks brought together by a broker in lieu of a commission. The broker handles neither the cash nor the securities, though that wasnt the case in the lead-up to the scam. In this settlement process, deliveries of securities and payments were made through the broker. That is, the seller handed over the securities to the broker, who passed them to the buyer, while the buyer gave the cheque to the broker, who then made the payment to the seller. In this settlement process, the buyer and the seller might not even know whom they had traded with. This the brokers could manage primarily because by now they had become market makers and had started trading on their account. To keep up a semblance of legality, they pretended to be undertaking the transactions on behalf of a bank. Another instrument used in a big way was the bank receipt (BR). In a ready forward deal, securities were not moved back and forth in actuality. Instead, the borrower, i.e. the seller of securities, gave the buyer of the securities a BR. As a BR confirms the sale of securities. It acts as a receipt for the money received by the selling bank. Hence the name - bank receipt. It promises to deliver the securities to the buyer. It also states that in the mean time, the seller holds the securities in trust of the buyer. Having figured this out, Metha needed banks, this could issue fake BRs, or BRs not backed by any government securities. Two small and little known banks - the Bank of

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Karad (BOK) and the Metorpolitan Co-operative Bank (MCB) - came in handy for this purpose. These banks were willing to issue BRs as and when required, for a fee. Once these fake BRs were issued, they were passed on to other banks and the banks in turn gave money to Mehta, obviously assuming that they were lending against government securities when this was not really the case. This money was used to drive up the prices of stocks in the stock market. When time came to return the money, the shares were sold for a profit and the BR was retired. The money due to the bank was returned. The game went on as long as the stock prices kept going up, and no one had a clue about Mehtas modus operandi. Once the scam was exposed, though, a lot of banks were left holding BRs which did not have any value - the banking system had been swindled of a whopping Rs 4,000 crore.

Mehta made a brief comeback as a stock market guru, giving tips on his own website as well as a weekly newspaper column. This time around, he was in cahoots with owners of a few companies and recommended only those shares. This game, too, did not last long. Interestingly, however, by the time he died, Mehta had been convicted in only one of the many cases filed against him.

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2. Ketan Parekh:-

Ketan Parekh was a chartered accountant by profession and used to manage a family business, NH Securities started by his father. Known for maintaining a low profile, KP's only dubious claim to fame was in 1992, when he was accused in the stock exchange scam. The companies in which KP held stakes included Amitabh Bachchan Corporation Limited (ABCL), Mukta Arts, Tips and Pritish Nandy Communications. He also had stakes in HFCL, Global Telesystems (Global), Zee Telefilms, Crest Communications, and PentaMedia Graphics KP selected these companies for investment with help from his research team, which listed high growth companies with a small capital base. According to media reports, KP took advantage of low liquidity in these stocks, which eventually came to be known as the 'K-10' stocks. Mutual funds like Alliance Capital, ICICI Prudential Fund and UTI also invested in K-10 stocks, and saw their net asset value soaring. By January 2000, K-10 stocks regularly featured in the top five traded stocks in the exchanges. HFCL's traded volumes shot up

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from 80,000 to 1,047,000 shares. Global's total traded value in the Sensex was Rs 51.8 billion. As such huge amounts of money were being pumped into the markets, it became tough for KP to control the movements of the scrips. Also, it was reported that the volumes got too big for him to handle. Analysts and regulators wondered how KP had managed to buy such large stakes. According to market sources, though KP was a successful broker, he did not have the money to buy large stakes. According to a report, 12 lakh shares of Global in July 1999 would have cost KP around Rs 200 million. The stake in Aftek Infosys would have cost him Rs 50 million, while the Zee and HFCL stakes would have cost Rs 250 million each. Analysts claimed that KP borrowed from various companies and banks for this purpose. His financing methods were fairly simple. He bought shares when they were trading at low prices and saw the prices go up in the bull market while continuously trading. When the price was high enough, he pledged the shares with banks as collateral for funds. He also borrowed from companies like HFCL. This could not have been possible out without the involvement of banks. A small Ahmadabad-based bank, Madhavapura Mercantile Cooperative Bank (MMCB) was KP's main ally in the scam. KP and his associates started tapping the MMCB for funds in early 2000. In December 2000, when KP faced liquidity problems in settlements he used MMCB in two different ways. First was the pay order route, wherein KP issued cheques drawn on BoI to MMCB, against which MMCB issued pay orders. The pay orders were discounted at BoI. It was alleged that MMCB issued funds to KP without proper collateral security and even crossed its capital market exposure limits. The second route was borrowing from a MMCB branch at Mandvi (Mumbai), where different companies owned by KP and his associates had accounts. KP used around 16 such accounts, either directly or through other broker firms, to obtain funds. Apart from direct borrowings by KP-owned finance companies, a few brokers were also believed to have taken loans on his behalf. KP's modus operandi of raising funds by offering shares as collateral security to the banks worked well as long as the share prices were rising, but it reversed when the markets started crashing in March 2000. The crash, which was led by a fall in the NASDAQ, saw the K-10 stocks also declining. KP was asked to either pledge more shares as collateral or return some of the borrowed money. In either case, it put pressure on his financials. By April 2000, NAVNIRMAN INSTITUTE OF MANAGEMENT

mutual funds substantially reduced their exposure in the K-10 stocks. In the next two months, while the Sensex declined by 23% and the NASDAQ by 35.9%, the K-10 stocks declined by an alarming 67%. It was alleged that 'bear hammering' of KP's stocks eventually led to payment problems in the markets. The Calcutta Stock Exchange's (CSE) payment crisis was one of the biggest setbacks for KP.Though officially the scrips were in the brokers' names, unofficially KP held them. KP used to cover any losses that occurred due to price shortfall of the scrips and paid a 2.5% weekly interest to the brokers. By February 2001, the scrips held by KP's brokers at CSE were reduced to an estimated Rs 6-7 billion from their initial worth of Rs 12 billion. The situation worsened as KP's badla payments of Rs 5-6 billion were not honored on time for the settlement and about 70 CSE brokers, including the top three brokers of the CSE (Dinesh Singhania, Sanjay Khemani and Ashok Podar) defaulted on their payments. By mid-March, the value of stocks held by CSE brokers went down further to around Rs 2.5-3 billion. The CSE brokers started pressurizing KP for payments. KP again turned to MMCB to get loans. The outflow of funds from MMCB had increased considerably from January 2001. To revive the markets, SEBI imposed restriction on short sales and ordered that the sale of shares had to be followed by deliveries. A historical decision to ban the badla system in the country was taken, effective from July 2001, and a rolling settlement system for 200 Group A shares was introduced on the BSE. KP was released on bail in May 2001. The duped investors could do nothing knowing that the legal proceedings would drag on, perhaps for years. Observers opined that in spite of the corrective measures that were implemented, the KP scam had set back the Indian economy by at least a year. Reacting to the scam, all KP had to say was, "I made mistakes." It was widely believed that more than a fraud, KP was an example of the rot that was within the Indian financial and regulatory systems. Analysts commented that if the regulatory authorities had been alert, the huge erosion in values could have been avoided or at least controlled. After all, Rs 2000 billion is definitely not a small amount even for a whole nation.

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3. Ramalinga Raju:-

Born September 16, 1954 (age 56) Garagaparru Village, Bhimavaram, Andhra Pradesh, India Residence Nationality Occupation Spouse Hyderabad, India Indian former Chairman of Satyam Computer Services Nandhini

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Byrraju Ramalinga Raju founded Satyam Computers in 1987 and was its Chairman until January 7, 2009 when he resigned from the Satyam board after admitting to cheating six million shareholders, some of whom have lost their entire life savings. After being held in Hyderabad's Chanchalguda jail on charges including cheating, embezzlement and insider trading, Raju was granted bail on 18 August 2010. A botched acquisition attempt involving Maytas in December 2008 led to a plunge in the share price of Satyam. In January 2009, Raju indicated that Satyam's accounts had been falsified over a number of years. He admitted to an accounting dupery to the tune of 7000 crore rupees or 1.5 Billion US Dollars and resigned from the Satyam board on January 7, 2009. In his letter of resignation, Raju described how an initial cover-up for a poor quarterly performance escalated: "It was like riding a tiger, not knowing how to get off without being eaten. " Raju and his brother, B Rama Raju, were then arrested by the Andhra Pradesh police on charges of breach of trust, conspiracy, cheating, falsification of records. Raju may face life imprisonment if convicted of misleading investors. Raju had also used dummy accounts to trade in Satyam's shares, violating the insider trading norm. It has now been alleged that these accounts may have been the means of siphoning off the missing funds. Raju has admitted to overstating the company's cash reserves by USD$ 1.5 billion. Raju was hospitalized in September 2009 following a minor heart attack and underwent angioplasty. Raju was granted bail on condition that he should report to the local police station once a day and that he shouldn't attempt to tamper with the current evidence. This bail was revoked on 26 October 2010 by the Supreme Court of India and he has been ordered to surrender by 8 November 2010. The people of his native village, Garagaparru, hail the development works undertaken by the Byrraju Foundation, the charitable arm of Satyam. Ramalinga Raju may head Indias first BPO from prison.

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The scam at Satyam Computer Services, the fourth largest company in Indias much showcased and fiscally pampered information technology (IT) industry, has had an unusual trajectory. It began with a successful effort on the part of investors to thwart an attempt by the minority-shareholding promoters to use the firms cash reserves to buy out two companies owned by them Maytas Properties and Maytas Infra. That aborted attempt at expansion precipitated a collapse in the price of the companys stock and a shocking confession of financial manipulation and fraud from its chairman, B. Ramalinga Raju.

What is known as of now is that over an extended period of time, the promoters decided to inflate the revenue and profit figures of Satyam. In the event, the company has a huge hole in its balance sheet, consisting of non-existent assets and cash reserves that have been recorded and liabilities that are unrecorded. According to the confessional statement of Mr. Raju, the balance sheet shortfall is more than Rs.7000 crore.

Why did a leading company in one of Indias most successful industries of recent years need to inflate profits? After all, the revenues of Indias IT industry have grown at a scorching compound annual rate of almost 30 per cent in the past eight years, driven by exports. This is remarkable, assuming that revenue and profit inflation have not excessively overstated performance. With cheap skilled labour having shored up profits that were lightly taxed when compared with the norm, net profits must have been substantial and rising too. Why then did the fourth largest IT company choose to take the criminal route of falsifying accounts and indulging in fraud? One possible cause could be the desire to drive up stock values. The benefits derived by promoters from high stock values are obvious, allowing them to buy into real wealth outside the company and giving them the invasion money to acquire large stakes in other firms. This tendency was epitomised by the benefits derived by America Online when it merged with Time Warner. Although the latter had more assets, revenues, and customers, AOLs

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higher market capitalisation led to that company and its chairman, Steve Case, getting more out of the deal than did long-time giant Time Warner.

There is some suspicion that Mr. Raju and his family may have sought similar benefits. The family chose to build its shareholding in Satyam Computer Services and shed it when required. For example, in year 2000 Satyam Computer merged with a related company, Satyam Enterprises. Rajus cousin, C. Srinivasa Raju, who held 800,000 shares, or 19 per cent, in Satyam Enterprises, was reportedly allotted an equivalent number in Satyam Computer, leading to criticism that relative prices did not justify the 1:1 swap.

But the original promoters share held by the Raju family and their subsequent acquisitions were not for keeping. Though the precise numbers quoted vary, according to observers the stake of the promoters fell sharply after 2001 when they held 25.60 per cent of equity in the company. This fell to 22.26 per cent by the end of March, 2002, 20.74 per cent in 2003, 17.35 per cent in 2004, 15.67 per cent in 2005, 14.02 per cent in 2006, 8.79 in 2007, 8.65 at the end of September 2008, and 5.13 per cent in January 2009 (Business Line, January 3, 2009). The most recent decline is attributed to the decision of lenders from whom the family had borrowed to sell the shares that were pledged with them. But the earlier declines must have been the result either of sale of shares by promoters or of sale of new shares to investors. According to audited balance sheet figures (if they are to be trusted) available from the CMIEs database, the paid-up equity in Satyam Computer Services rose from Rs. 56.24 crore in March 2000 to just Rs. 64.89 crore by March 2006 and further to Rs. 133.44 crore in March 2007. Overall, the number of shares held by the promoter group fell from 7.16 crore (22.8 per cent) to 5.8 crore (8.6 per cent) between September 2001 and September 2008.

This points to a conscious decision by the promoters to sell shares, which may have been used to acquire assets elsewhere. The more inflated the share values, the more of such assets could be acquired. It is quite possible that the assets built up by the eight other Raju family companies under scrutiny, including Maytas Properties and Maytas Infra, partly came from the resources generated through these sales. If true, this makes Rajus NAVNIRMAN INSTITUTE OF MANAGEMENT

confession suspect, since he stated that neither myself, nor the Managing Director (including our spouses) sold any shares in the last eight years excepting for a small proportion declared and sold for philanthropic purposes.

This may not have been the only way in which resources were transferred out of Satyam Computer Services into other arms of the expanding Raju family empire. Money could have been siphoned out through opaque transactions with beneficiaries who were paid sums not warranted by their business profile. Satyams business strategy did involve unusual transactions. One example was the acquisition in 1999 by group company Satyam Infoway, which was the largest private Internet Services Provider in the country at that time, of IndiaWorld Communications, for a sum of $115 million. The acquired company operated popular portals such as samachar.com and khel.com that had no clear revenue model, and was the principal beneficiary just as in the AOL deal. According to reports, the owner of IndiaWorld was himself charged with intellectual property violations by his erstwhile employer IndiaWorld.com, an Internet services company managed by U.S.-based ASAP Solutions Inc. Satyam Infoways position was that it was aware of the claim being made by ASAP Solutions, but that its interest was not in IndiaWorld.com but was limited to the URL indiaworld.co.in and the other portals under its banner, for which it had of course paid a huge sum. There is reason to suspect that this acquisition delivered little to the company, raising questions about the motivation.

Mr. Rajus confession is also suspect for another reason, which has been widely discussed in the media. Even if he and his colleagues were inflating revenues and profits, the actual revenue earning capacity of the company, as confessed by him, seems to be extremely low. He claims that the huge difference between actual and reported profits in the second quarter of 2008-09 was because the ratio of operating margins to revenues was just 3 per cent rather than the reported 24 per cent. But even if Satyam Computer Services was cooking its books, it was engaged in activities similar to that undertaken by other similarly placed IT or ITeS companies and it too had a fair share of Fortune 500 companies on its client list. It is known that

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many of these companies have been showing operating margins that are closer to the 24 per cent reported by Satyam than the 3 per cent revealed in Mr. Rajus confession. Thus in financial year ending March 2008, the ratio of profits before tax of Infosys was 32.3 per cent of its total income, that of TCS 23.1 per cent, of Satyam 27.8 per cent, and that of Wipro 19.2 per cent.

This suggests that either Mr. Raju is exaggerating the hole in his balance sheet or there is some other, more complex, and more disturbing explanation. But whatever it is, the difference between 24 per cent and 3 per cent seems too large to be the industry standard.

Despite indicators of these kinds, which could raise suspicion, Satyam Computer Services remained a leading player with substantial investor support for many years. The promoters continued to hold control over the company despite the small share in equity they held and built an empire with land assets and contracts for executing prestigious infrastructural projects. And despite its award-winning reputation for corporate governance, its impeccable board with high-profile independent directors, and its appointment of big-four member PwC as its auditor, this still mysterious accounting fraud occurred. The full truth, it appears, is not yet out.

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