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The Scandal That Transformed And Empowered SEBI

We’ve spoken about SEBI before. However, there is an interesting backstory to how SEBI (as we know it today!) came to be.

It has gone through quite a transformation since its inception in the 90s, and one of the catalysts in this transformation was the Harshad Mehta scandal. The Harshad Mehta scandal, which rocked the Indian financial markets in the early 1990s, exposed glaring weaknesses in the regulatory framework governing the country’s securities market. The Securities and Exchange Board of India (SEBI) was still in its nascent stage, and its limited powers left the market vulnerable to manipulation and fraud. However, this event served as a catalyst for significant changes in SEBI’s powers and responsibilities, ultimately shaping it into the robust regulatory body it is today.

We thought it would be interesting to dive into this unique case study, that set in motion the evolution of SEBI.

SEBI

Here’s an Overview of the Scandal

In the early 1990s, Harshad Mehta, a stockbroker orchestrated one of the most significant financial scandals in Indian history, by manipulating the Bombay Stock Exchange (BSE). We’re sure your parents will be able to tell you all about it – it was news that was being splashed across media outlets! (If not that, you’ve definitely watched or heard of the show based on the same happenings!)
Mehta, often referred to as the “Big Bull,” exploited regulatory gaps and loopholes to manipulate stock prices, rig the bond market, and divert funds from banks into the stock market – ultimately swindling banks out of 1000s of crores. His manipulation of the stock market led to a meteoric rise in the prices of certain stocks, which later came crashing down, causing substantial losses to investors.

The Consequences of the Scandal

As a response to the scandal, the Reserve Bank of India formed the Janakiraman Committee in 1992. The aim of the committee was to get accurate details of Mehta’s scam into the spotlight. The Bombay High Court and the Supreme Court convicted him and charged him with 74 criminal offenses. 

The Harshad Mehta scandal exposed the alarming inadequacies in India’s securities market regulation. There was a very clear need for a more substantial approach to financial regulation in the country. As a response to this financial catastrophe, the Indian government recognized the urgent need to enhance SEBI’s powers and improve its capabilities to prevent similar incidents from occurring in the future. In 1995 the Securities Laws (Amendments) Act was passed to expand the scope of SEBI’s jurisdiction as a regulatory body for the Indian financial sector.

SEBI’s Transformation

Here are some of the important ways in which SEBI was empowered to become the formidable establishment that it is today.

  1. Power to Enforce – One of the significant changes that occurred after the Harshad Mehta scandal was the empowerment of SEBI to enforce regulatory actions and penalties against market manipulators and wrongdoers more effectively. SEBI was given the authority to initiate investigations, conduct search and seizure operations, and impose substantial penalties on entities found guilty of market manipulation, insider trading, and other fraudulent activities. This change in powers marked a significant shift in SEBI’s role, transforming it into a more proactive and assertive regulator.

  2. Power to Oversee – The scandal also revealed the need for SEBI to expand its regulatory oversight to cover a broader spectrum of financial instruments and market participants. At the time, SEBI primarily focused on regulating stocks and bonds, while the scandal exposed how manipulators had exploited the relatively unregulated government securities market. In response, SEBI was granted authority to regulate a wider range of financial instruments, including derivatives and mutual funds. This expansion of SEBI’s jurisdiction allowed it to develop a comprehensive regulatory framework that could adapt to the evolving complexities of the financial markets.

  3. Power to Protect – Another vital aspect of SEBI’s transformation post-Harshad Mehta was a renewed focus on investor protection. The scandal led to massive losses for retail investors, and it became evident that stronger measures were needed to safeguard their interests. To address this, SEBI introduced various measures to enhance investor protection, such as stricter disclosure requirements and mechanisms for redressal of investor grievances. SEBI also mandated stringent Know Your Customer (KYC) norms for market participants, making it harder for unscrupulous individuals to defraud investors. Additionally, the Investor Protection Fund was established to compensate investors who suffered losses due to market manipulation or broker defaults.

  4. Power to Inform – The Harshad Mehta scandal demonstrated the importance of market transparency and the need to ensure that investors had access to accurate and timely information. SEBI took significant steps to enhance market transparency by implementing measures such as improved disclosure requirements for companies, more stringent reporting norms, and the introduction of electronic trading platforms. The introduction of electronic trading systems not only improved the efficiency of the markets but also reduced opportunities for manipulation. The move towards a dematerialized system for shares and securities also contributed to greater transparency and reduced the scope for fraudulent activities.

  5. Power to Govern – Corporate governance was another area that underwent significant changes. The scandal highlighted the role of lax corporate governance in facilitating market manipulation. To address this issue, SEBI introduced a series of corporate governance reforms, including guidelines for independent directors, audit committees, and the disclosure of related party transactions. These reforms aimed to instill greater accountability and transparency within companies and ensure that corporate insiders could not misuse their positions for personal gain. The focus on corporate governance reform has played a vital role in restoring investor confidence in the Indian stock market.

It is also interesting to note that the Harshad Mehta scandal emphasized the interconnectedness of the global financial markets. It became clear that to prevent market manipulators from exploiting the market, India needed to align its regulatory framework with global standards. SEBI has since actively engaged in international collaborations and established agreements with various foreign regulators to facilitate information sharing and cooperation. This has not only helped in the early detection of cross-border market manipulation but has also enhanced India’s reputation as a responsible and well-regulated financial market.

Over the years, SEBI has continued to evolve and adapt to the changing dynamics of the financial markets. The lessons learned from the Harshad Mehta scandal have helped shape SEBI into a more formidable regulator, capable of safeguarding the interests of investors and maintaining the integrity of the Indian securities market. 

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