MAJOR STOCK MARKET SCAMS
When the bulls make mistakes, the sheep suffer the consequences
All the traders we are going to talk about found loopholes in the banking system and exploited them to create an insane amount of wealth. Here are some instances from the Indian Stock Market
- HARSHAD MEHTA SCAM:
Adjusted to the inflation rates today, Harshad Mehta laundered over 24000 crore rupees in a period of 3 years his story began when he joined New India Insurance Company as a salesperson when he first got interested in the stock market.
He then quit his job and joined a brokerage firm in Bombay Stock Exchange and made contacts with big brokers and within 3 years became a broker himself with the BSE. By 1990s he had risen to prominence in the Indian stock markets, so much that he established his own brokerage firm with his cousin called Grow More Research and Asset Management. But his lust for money was not satisfied.
At the time the reserve bank used to issue securities in form of government bonds for various projects, and all the banks were supposed to have a certain amount of govt bonds else RBI would penalize them.
Now there were some strong banks and there were some weak banks. The strong banks had no problem keeping the minimum balance of the bonds whereas the weak banks struggled. So weak banks had to borrow the bonds from the strong banks and in return, they paid some interest. These transactions were not done directly between the banks but through brokers and Harshad Mehta was one of them.
By this time, Harshad Mehta had become a very reputed and influential broker. So, what he used to do was he would borrow the govt bonds from the small banks and large sums of money from the big banks and would ask for some time to find the respective buyers and sellers for the bonds.
Due to his reputation, neither of the parties had any problem with lending to him. He used to take advantage of this trust and used the money he borrowed from the big banks to manipulate the stock prices of a particular company. He would invest in the market so heavily that the other investors, anticipating that the market would rise further, invested heavily in the market. Then when the price was high enough for him, he would sell the stocks and generate massive profits from them. Now using this profit, he used to give the promised money to the big banks and the securities to small banks and so everyone was happy.
Also, he used to deal with multiple banks at the same time and so due to this Ponzi scheme, he always had an excess flow of money which he used to invest further to manipulate the stocks.
Due to the liquidity injection he used to give to the stock market, the index of BSE(Sensex) quadrupled its value in a period of one year. He became so greedy that he used to conspire with officials of various banks to make fake bond receipts and used them to borrow money from the banks and increase the stock prices of companies. Harshad Mehta raised the price of ACC stocks from 200 rupees to about 9000 rupees.
But this show began to come to an end when a journalist named Sucheta Dalal, published an article in the TOI exposing the scams of Harshad Mehta.
So due to this all the senior officials in the banks were alerted and thanks to the article, the stock prices of all the companies came crashing down and so he was not able to return the money borrowed from the banks.
He was finally charged with 70 cases of fraud and put into Thane jail. Due to this stunt he pulled, managers of various banks lost their jobs, and many committed suicide.
But some investors like Rakesh Jhunjhunwala and Radhakrishnan Damani made money by shorting the stocks and betting against the market. So, we can say that only those win in the stock market who have an understanding of how the market works and not those who just throw their money on any rising stock.
2. KETAN PAREKH SCAM:
Ketan Parekh was a Chartered Accountant who used to work as a trainee in Harshad Mehta’s company Grow More Research and Asset Management.
Where Harshad Mehta targeted retail investors, Ketan Parekh on the other hand targeted Institutional investors such as mutual funds, hedge funds, etc which was very easy for him as he was an institutional stockbroker.
He used the pump and dump scheme to attract investors. First, he used to buy great stakes in some stocks and then used to manipulate the stock prices of those stocks to attract institutional investors.
All the big institutional investors give a lot of priority to the liquidity of stocks. So, what Ketan Parekh used to do was he would buy a lot of stocks of a particular company, and then he would start doing circular trading to increase the volume of the stocks which would eventually look like the stocks of that company are in high demand. He mainly used to manipulate stock prices of 10 companies which later came to be known as K-10 stocks. He also invested heavily in these stocks to increase their price. He had contacts with some institutional investors who then invested in those stocks on his request. Due to this, retail investors also started investing in the K-10 stocks.
During this time, that is from 1997–2002, the dotcom boom was also a major factor. The majority of the K-10 stocks were of technological and telecom equipment provider companies due to which it looked like the stocks were actually in demand and investors are genuinely interested in those stocks. So, all investors used to think that the prices of stocks are rising due to good fundamentals, future growth, and the dot-com boom.
Some of the major K-10 stocks were Pentafour Software, HFCl, Global Telesystem and Zee. So, he used to sell the stocks of these companies when he thought that the prices of the stocks have become sufficiently high. This used to make him massive profits.
To run his scam, he used to get money from two sources, promoters of the companies and banks. Promoters used to buy shares of a company and then bribe Ketan Parekh to manipulate the price of those stocks.
Now coming to banks, he used to get his funds mainly from two of them, Global Trust Bank (GTB) and Madhavpura Mercantile Corporative Bank(MMCB).
Ketan Parekh used to buy stocks when prices were high and use those stocks as collateral to get loans from GTB, and then used this money to increase the stock prices. He was a major stakeholder in both of the banks and with the help of some officials at these banks, he used to arrange for funds to manipulate the stock prices. GTB loaned him 100 crore rupees and MMCB loaned him over 800 crores as funds, even when RBI had made a rule to not give loans to any stockbrokers above 15 crores. He took advantage of pay orders just as Harshad Mehta had used government bonds in his ready forward deal. MMCB played an important role in his scam.
Pay order is a prepaid instrument for banks, where a person needs to pay the amount in full to the bank issuing the pay order. Then he used to exchange these pay orders for money from the Bank of India stock exchange branch. Bank of India used to send pay orders to RBI for clearance and if the pay order didn’t return in 3 days, it used to be considered as cleared. In March 2001, MMCB issued 137 pay orders for Ketan Parekh. Here RBI made a mistake. Due to some issues, it took 11 days for RBI to send back the pay orders back to the bank of India, and by that time the pay orders were already cleared.
Now the scam started to come into the light. After the RBI reported that MMCB did not have enough money to issue the pay orders, Bank of India accused Ketan Parekh of fraud of 137 crore rupees. Ketan Parekh’s scam was also exposed by Sucheta Dalal who helped exposing Harshad Mehta. As this scam was exposed, the prices of K-10 stocks declined drastically and most of the investors suffered huge losses.
Here are some examples from Wall Street
3. BERNIE MADOFF: BIGGEST PONZI SCHEME IN THE HISTORY OF STOCK MARKET:
Bernard Madoff is considered one of the finest con and the greatest pathological liar in the history of the stock market. He single-handedly pulled off a scam worth more than $65 billion without actually ever investing in the stock market in the past 15 years.
Bernie Madoff was a big name from the early 1990s. He was considered a financial wizard who had a supposed investing experience of fifty years. He had been the chairman of NASDAQ for 3 years.
He used to tell people that he will be able to give a stable 1–2 % returns per month on their investment. He was considered trustworthy due to his influential figure and history in the world of the stock market. But if he never invested a single dollar in 15 years of running his own brokerage firm, then how was he able to pull this off.
At the age of 22, he established his own brokerage firm called Bernard L Madoff Investment Securities. He passed the General Securities Representative exam, allowing him to get a stockbroker’s license and also the General Securities Principal exam on the same day. He started his business with the aid of a $50000 loan from his father in law. He started with specialising in selling penny stocks. The work offered long hours, cold calls, and little rewards. Later in the year, he started trading on behalf of individuals. Bernie grew this firm impressively. He started a system of an investment concept called feeders who will bring him investors to bring in cash. He would invest and grow the cash and then keep a portion and disperse the rest back to the investor.
In 1970 Bernie embraced the computer technology quickly outfitting his office with the latest equipment. By the 1980s he was making to the north of $100 million a year.
What he was doing was nothing but running a Ponzi scheme. He took money from the investors but never actually invested them. At the end of each month, he would give back the investors the promised amount from the money they only paid to him.
To show that all of it was legit, Madoff used to send the investors a fabricated receipt showing that everything was online. Then he would take money from other investors and do the same with them. As a result, he always had an excess flow of cash with him.
The unraveling began in 1999 when Harry Markopolos, the Chief Investment Officer of Rampart Investment Management, was assigned to replicate a system similar to Madoff’s. He had heard from one of the partner companies of Rampart Investment Management, that they were getting a stable 1–2% returns per month on their investment trading through Madoff’s firm. He knew that the returns cannot be that stable until and unless Madoff was either trading on insider information or was running a Ponzi scheme, both of which are white-collar crimes and punishable by the Securities and Exchange Commission (SEC). The policies were too good to be true. But the SEC did not take any action as Bernie was an influential figure and it seemed senseless that a man could pull off such a scam alone.
The problem began in 2008 when the inflow of money started to dry off. So as the market went down entirely, all the investors started asking for their money. The amount that had to be paid was $7 billion but Bernie in total had about $300-$400 million. So finally, on December 11, 2008, he was charged with securities fraud. In the early months of next year, he was charged with 11 federal felonies, fraud, money laundering, and perjury among them. All the investors who traded with him suffered huge losses and they had nothing. No investment, no returns just a big web of lies made up by the wizard of wall street.
This article will be incomplete without the scam of the infamous wolf of the wall street Jordan Belfort.
4. JORDAN BELFORT:
Jordan Belfort is also considered one of the greatest con artists in the history of the stock market who stole over $200 million as a stockbroker.
He always had a good business sense and great convincing power which he used in his favor. At an early age of 16, he was successful in making a profit of $20000 by selling shaved ice on the beach. At a very young age, he used to work as a trainee in a brokerage firm called LF Rothschild where he gained knowledge and interest in the securities industry. But soon after that, the stock market crashed on Black Monday and he lost his job in the firm.
Then in 1989 itself, he started his own company called Stratton Oakmont which was a franchise of Stratton Securities, another brokerage firm which was later bought by him. Jordan used his skills and knowledge to manipulate penny stocks which were traded over the counter and not on the stock exchange. As very less information was available about these penny stocks, they were of great advantage to him.
So, he used to buy a huge amount of stocks at a very cheap price, and then he used to fabricate positive information about the company to pitch it to the investors.
So basically, he used pump and dump scheme to manipulate the demand of the stocks and when these penny stocks reached a good price, he used to sell all the stocks and stopped convincing the investors to buy these stocks, due to which the demand decreased and other investors suffered losses. But before selling penny stocks to investors, he used to give them an actual tip for the blue-chip stocks to establish trust in the investors’ minds.
He used to keep all his profits in Swiss banks and used other money laundering techniques to make profits. But soon, because of his lavish lifestyle and constant show off, he came under the surveillance of the Securities and Exchange Commission(SEC). Soon all of his scams and frauds were exposed and due to that, all the penny stock companies were shut as the share prices declined continuously.
Stratton Oakmont was under near-constant scrutiny from the National Association of Securities Dealers (now the Financial Industry Regulatory Authority) from 1989 onward. Finally, in December 1996, the NASD expelled Stratton Oakmont, putting it out of business.[23] Belfort was then indicted for securities fraud and money laundering in 1999.
He was sentenced to do 4 years in prison and a fine of $110.4 million for causing the investors a massive loss of $110 million. When this happened, he ratted out all of his accomplices, and his sentence was reduced to only 22 months and the fine.
CONCLUSION
So, we can say that none of the scam artists end up well and that we should not invest in the market based on any kind of tips we receive, but only on our own evaluations of the market because, only when the market crashes and there is uncertainty, the real culprits come into the light.
