Economic Scams in India

Anonymous

Editor’s note:

India has been home to several scams post 1992, resulting to losses amounting to lakhs of crores of rupees to the economy. These include, in reverse chronological order, the 2G scam, Satyam Scandal, UTI Scam, Fodder scam, and the Harshat Mehta scam. Scams may be defined as persistent manipulation of public funds, the prevention of which resulted in the formation of SEBI. This paper discusses the gravity of the problem, how scams affect the economy, and a few major scams witnessed by the country.

Introduction

Post-liberalization period, Indian economy has witnessed several scams like Harshat Mehta Scam in 1992, Fodder Scam 0f 1996, UTI Scam of 2001, Satyam Scandal and most recently the 2G scam. These scams have just not led to the loss of millions of rupees but have also affected the economy in a major way. The scale of these economic crimes and the way in which these crimes have been committed are a serious concern to the Government as well as to the people.[1]

Approximately 73 lakh crore rupees have been lost due to the economic scams since 1992.[2] Indian economy lost almost 6,600 rupees in the fiscal year of 2012 alone.[3] These scams have affected all the sectors of the economy.

The Joint Parliamentary Committee on Stock Scam of 2001 defined scam as:-

Individual cases of financial fraud in them may not constitute a scam, but persistent and pervasive manipulation of public funds falling under the purview of statutory regulators and involving issues of governance, becomes a scam.”[4]

The regulation of financial market is one of the constant challenge which government faces. The government established the Securities and Exchange Board of India in 1992 to protect the interests of investors in securities and to regulate the securities market.[5] The ever changing nature of these scams have kept the SEBI on its toes and necessitated the need for its empowerment. The government recently passed the Securities Law (Amendment) Bill, 2014 to empower the SEBI and to protect the interests of investors in a better way.[6]

These scams can affect the economy of the nation as a whole and in a globalized world where all the countries are related by trade and other means these scams can damage the world economy at large. For example, a systemic risk occurs when few brokers monopolize the transaction of securities leading to a lack of liquidity in the economy.

Gravity of the Problem

Economic offenders by engaging in various illegal trade practices and by way of scams have swindled off millions and billons of money and have exploited all the areas of economic activity. The various areas in which scams and frauds have affected the economy are:-

  1. Primary Market Frauds:-

    Primary market is that part of capital market wherein corporates issue new securities for raising funds.[7] These funds are generally raised through IPO’s (Initial Public Offers). There have been several IPO frauds in which many operators and companies after collecting thousands of crores of rupees from people have vanished. In November 2013, SEBI seized Rs 1,544 crores from bank accounts of peoples and companies who were indicted of the IPO frauds.[8]

  2. Secondary Market Frauds:-

    Insider trading is a common unfair practice in which traders who are insiders to an organization manipulate and misuse the unpublished sensitive information. When the people who are insiders to an organization trade using the information which is not public, it becomes unfair for the investors who don’t have access to such information. Inside trading violates the basic principle of fair trading and is an extension of asymmetrical information. The Securities and Exchange Board of India imposes a prohibition on dealing, communicating or counseling on matters relating to inside trading.[9] This unfair practice is quite common in India in which share prices are artificially rigged so as to profit the ‘insider’. This leads to a loss to the common investors.

  3. Fake Currency:-

    “ Large scale circulation of fake currency can undermine the economy as well as the national security of a country.”[10] The counterfeited notes are used by the terrorists to fund their operations. Thus, this is not just an economic crime but also a threat to the security of our country.

The other forms of economic crimes are listed below:-

  • Import/Export Frauds
  • Insurance frauds
  • Fake stamp paper
  • Fodder scams

A case study of several economic scams and frauds is analyzed below:-

Fodder Scam of 1996

Introduction

The Fodder Scam of 1996 was a corruption scandal involving the alleged embezzlement of approximately Rs. 950 crore from the government treasury of the poor state of Bihar.[11] Although the report of the scandal broke in 1996, the theft had been in progress, and increasing in magnitude, for over two decades.[12]  Apart from the money embezzled in this scam, the scam glared the eyes of the public because of the involvement of the then Chief Minister of Bihar whose party was one of the major allies of the Central Government. Thus, the scam involved huge political consequences also. The New York Times then reported that the scam had potential of bringing down the entire Government of India. Here is the excerpt from its 2nd July 1997 edition;

Barely 10 weeks after Prime Minister I. K. Gujral took office with a pledge to provide India with ‘clean government’, he is struggling to hold his ruling coalition together in the face of a corruption scandal that could send one of his most powerful political allies to jail. ”Fodder scam,” so-called because it involves vast herds of fictitious livestock, has stirred widespread concern, even in this country, which is weary of political corruption and scandal investigations that rarely result in convictions.” [13]

Beginnings of the scam

This scam spanned over a period of two decades. It originated in small-scale by officials in the state animal husbandry department withdrawing funds from the government treasury with fictitious bills.[14] The scam over a period of time grew in magnitude and created a nexus between politicians and bureaucrats. The scam went on without attracting much notice until 1990. The first report which indicated involvement up to the Chief Ministerial level was presented by then vigilance police inspector Bidhu Bhushan. He is now a witness in many of the fodder scam cases. The scam involved many bureaucrats and elected officials and “fabrication of vast herds of fictitious livestock for which fodder, medicines and animal husbandry equipment was supposedly procured.”[15]

Aftermath

The scam became a prime issue in the 90s as it involved role of the Chief Minister Lalu Prasad Yadav and many other leaders. The scam became a symbol of corruption and the criminalization of politics. “In the Indian parliament, it was cited as an important indicator of the deep inroads made by mafia raj in the politics and economics of the country.”[16] The Supreme Court of India ordered CBI probe to investigate the irregularities after a PIL was filed in the court. The CBI inquiry ultimately led to conviction of Lalu Prasad Yadav, Jagannath Mishra and almost 500 other people.[17]

The scam proved that the machinery of the government in the states as well as the centre was tainted with corruption. The trial was conducted at very slow pace as is evident from the fact that Lalu has been convicted after more than 17 years.

UTI scam of 2001

Introduction

The Unit Trust of India, formed in 1964 through an act of the parliament, is the largest mutual fund in the country. Mutual funds are financial institutions which give guaranteed returns to investors who invest in various schemes offered by them- of which the US-64 scheme is the largest of them all. UTI was set up specifically for channeling the relatively small savings that citizens have into investments by giving them back large returns. The US-64 scheme, in particular, has over 2 crore such investors, the bulk of them being small savers, widows, pentioners, etc.[18]

Methodology and Reservation

The 1991 liberalization of the economy indirectly led to the liberalization of the UTI. The US-64 scheme was converted from debt based fund into an equity based fund as a result. In 1997, when all the government nominees were removed by the government from the board of the UTI, the scheme in contention did not come under the regulation of the SEBI, thereby giving the chairman arbitrary power to decide investments up to Rs. 40 crore. Within one year of the reforms to the UTI, in 1998, it crashed. The incumbent BJP government organized a Rs. 3500 crore bailout package to save it. P.S. Subramanyum, who was appointed as the new chairman, gave directions for channeling funds into business houses, political offices and as well as into non performing bonds for commission. Thus, huge amounts of the UTI funds were directed to the now infamous K-10 list of Ketan Parekh stocks. UTI, meanwhile, continued to buy these shares even though their market value was beginning to crah in the mid-2000s in order to prop up the value of these shares. Thus finally, US-64 lost more than half of its 30,000 crore portfolio value within a year because of the fact that the ‘technology’ investments took place despite indications that the boom in that industry had ended. .

In August 2000, UTI bought Rs. 34 crores worth of shares in Cyberspace Infosys Ltd at an exorbitant price of Rs 930 per share.[19] Today, the shares have almost no valus and the promoters of the company are in jail. “Besides this, the UTI also invested in junk bonds like Pritish Nandy communications (Rs. 1.5 crores worth ), Jain Studios (Rs.5 crores worth), Sanjay Khan’s Numero Uno International (Rs. 7.5 crores worth), Malavika Spindles(Rs. 188 crores worth) etc. Thereby thousands of crores were siphoned off to big business and prominent individuals, with the UTI chairman taking his cut.”[20]

Two months before the freezing of dealings in UTI shares, a huge amount of Rs. 4,141 crores was redeemed. These were again purchased at the price of Rs. 14.20 per share (face value Rs. 10) when the actual price was below Rs. 8. Because of this UTIs small investors further lost Rs. 1,300 crores to the big corporates.[21]

Aftermath

Out of all the capital market scams in the post-liberalization era, the Unit Trust’s US-64 has been the worst. Its magnitude exceeds the stock market downswing of the mid-1990s, which wiped out Rs. 20,000 crores in savings.[22] This scam led not just to the loss of money but also the loss of lives as most of the small investors who invested their life savings into what they considered as a secured investment lost all their money. A majority of these small investors belonged to the middle class, the retired, the widows etc.

The Joint Parliamentary Committee setup to investigate the scam concluded that the scam took place due to the selfishness of a few individuals and negligence of management.[23]

Satyam Scandal

Introduction

Satyam Computers or Mahindra Systems, as it is called today, was found in the year 1987. The company was found by B. Ramalinga Raju and until recently, it was considered to be one of the leading Indian IT companies.[24] After the scandal broke out which made it impossible for the company to sustain itself, it was taken over by Mahindra Tech.

Methodology and Revelation

On 7th January 2009, the founder and Chairman of Satyam, B.R. Raju confessed to having embezzled Satyam’s account and gave his resignation.[25] The exposure of the scam commenced with a successful attempt by the investors to deter the usage of firm’s cash reserves by the minority shareholding promoters to buy out two companies owned by them, namely, Maytas properties and Maytas Infra. The abortion of this attempt of expansion resulted in a fall in the price of the Company’s stock lead by the astonishing revelation of fraud and mismanagement by the Chairman B.R. Raju. The promoters of the company had planned to inflate the earnings and the profit figures of Satyam. In causing so, the company had to fill a huge gap in its balance sheet which consisted of non-existent assets and cash reserves which were recorded and many other unrecorded liabilities. According to Raju, this gap or shortfall in the balance exceeded Rs. 7000 crores.

Even though the revenue of all the IT companies were increasing at that time at an estimated rate of 30% per annum, the promoters of the Satyam took an illegal route of exaggerating the company’s records and account. The probable reasons of this behavior can be[26]:-

  1. The desire to drive up stock value, which in turn gave the promoters benefits which allowed them to buy real wealth outside of the company.
  2. The increased stock value helped the company meet the increasing competition and diminish the threat of competition.
  1. The promoters gained personal benefits as they siphoned off the funds from company by using fraud tactics like creating 13000 ghost employees.[27]

Mr. Raju and his family derived unfair benefits from mergers and acquisitions within the family. For example, in year 2000 Satyam Computer merged with a related company, Satyam Enterprises. Raju’s 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.[28]

This however was not the only way by which promoters swindled off the money from Satyam Computers. The promoters kept on increasing their share in the company and invested in other firms like Maytas Properties. 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.

Furthermore, Promoters created fictional assets like 13000 ghost employees allowing them to transfer money from the company to their pockets.

The fictional assets and hidden liabilities were as follows:-

  1. The inflated figures of cash and bank balances was that of Rs. 5040 Crores as against the Rs 5360 Crores which was reflected in the books.
  2. An accrued interest of Rs. 376 Crores, which was non existent.
  3. An overstated debtors position of Rs 490 Crores as against the Rs 2651 Crores shown in the books.
  4. An understated liability of Rs 1230 Crore.[29]

Mr. Raju himself confessed that what started as a marginal gap between actual operating profit and the one in the actual book of accounts continued to grow over a period of years and gained huge proportions as the size of the company operations enlarged.

Measures Required to Stop Scams and other Economic Crimes

In the current running economy, the measures taken by the Indian government are not sufficient enough to solve the problems of over growing scams and other economic crimes. There is need of strict provisions to deal with such problems. The government is required to bring out certain reforms to overcome these issues such as to govern the crimes of economics the government should revamp the laws since the existing laws are not so harsh. Due to lack of such reforms, the economics scams are increasing day by day and the same not only rip-off the public money rather also affect the exchequer at high rates each year. Revamping of laws can put limits on the commission of such economics crimes. Also the enforcement agencies should try to keep bars on the benefits arising out of such crimes by the offenders or scam. Further, the state authority should tighten up the scope of bails provided to the offenders of scams. Along with these reforms, the judiciary also should ensure fast and speedy decisions regarding the trials of economic offenders. In this matter, the Indian reforms are much soft than of other countries. Side by side, all the private or public agencies such as income tax department, custom offices, police departments, SEBI, etc. should work in a coordination to quickly get rid of these economics crimes.

Conclusion

The security scams and the financial scandals which have been discussed above involve thousands of crores of money which either belongs to small investors, the government or cooperative banks. The offenders have comprehensive knowledge about the working of the system and know how to manipulate the system to benefit from it. But such benefits to some individuals come at the cost of loss of lakhs of rupees to millions of investors or the government.

It is clearly evident from the aforementioned cases that the occurrence and re – occurrence of such scams can only be attributed to the weak financial regulations and a failure of corporate governance in finance.

While the main aim of the corporate sector is to earn profit, it should not come at the cost of sacrificing ethics and professionalism. The corporates should have a concern about the welfare of the shareholders.

In all the drama that unfolds after every scam that is uncovered, ultimately it’s the honest man, who puts all his life savings into the share market who suffers the most. And what agonizes him more is that the perpetrators of his loss get away with a mere slap on their wrists.

Edited by Neerja Gurnani

[1] Patibandla, Murali. “Economic Reforms and Institutions: Policy Implications for India.” Economic and Political Weekly (1997): 1083-1090.

[2] Singh, Menjor. Economic Reforms in India: Problems & Prospects. Vol. 1. Mittal Publications, 2001. 98. Print.

[3] Singh, Menjor. Economic Reforms in India: Problems & Prospects. Vol. 1. Mittal Publications, 2001. 98. Print.

[4] Pathak, Bharthi V. The Indian Financial System: Markets, Institutions and Services. Pearson Education India, 2011. 136-138. Print.

[5] Parkash Arya, Parmatam, and B. B. Tandon. Economic Reforms in India: From First to Second Generation and Beyond. Vol. 2. Deep and Deep Publications, 2003. 75. Print.

[6] Lok Sabha passes Bill to give teeth to Sebi to tackle ponzi menace (Lok Sabha passes Bill to give teeth to Sebi to tackle ponzi menace)

http://zeenews.india.com/business/news/finance/lok-sabha-passes-bill-to-give-teeth-to-sebi-to-tackle-ponzi-menace_105588.html

[7] http://investor.sebi.gov.in/Reference%20Material/primarymarkets.pdf

[8] Singh, Sandeep. “In One Month,Sebi Seizes Rs 1,544 Cr from Bank Accounts of Defaulters.” Indian Express 6 Nov. 2013. 6 Nov. 2013. Web. 3 July 2014. <http://indianexpress.com/article/news-archive/web/in-one-month-sebi-seizes-rs-1-544-cr-from-bank-accounts-of-defaulters/>.

[9] Pathak, Bharthi V. The Indian Financial System: Markets, Institutions and Services. Pearson Education India, 2011. 131-132. Print.

[10] Kapila, Uma. India’s Economic Reforms. Vol. 1. Academic Foundation, 1996. 139. Print.

[11] F. BURNS, JOHN. “Fodder Scam’ Could Bring Down a Shaky Indian Government.” The New York Times 2 July 1997. 2 July 1997. Web. 1 July 2014. <http://www.nytimes.com/1997/07/02/world/fodder-scam-could-bring-down-a-shaky-indian-government.html>.

[12] Http://bhoolomat.com/case-detail.php?cid=23.” Web. 4 July 2014. <http://bhoolomat.com/case-detail.php?cid=23>.

[13] F. BURNS, JOHN. “Fodder Scam’ Could Bring Down a Shaky Indian Government.” The New York Times 2 July 1997. 2 July 1997. Web. 1 July 2014. <http://www.nytimes.com/1997/07/02/world/fodder-scam-could-bring-down-a-shaky-indian-government.html>.

[14] “Fodder Scam.” Economic and Political Weekly 14 June 1998. 14 June 1998. Web. 4 July 2014. <http://www.epw.in/commentary/fodder-scam-lalu-and-conviction.html>.

[15] Singh, Santosh. “Once There Was a Scam.” Indian Express 15 July 2008. 15 July 2008. Web. 30 June 2014. <http://archive.indianexpress.com/news/once-there-was-a-scam…/335964/2>.

[16] Singh, Santosh. “Verdict in Fodder Scam Case, a Justice Day for Biha.” DNA 30 Sept. 2013. 30 Sept. 2013. Web. 30 June 2014. <http://www.dnaindia.com/india/report-verdict-in-fodder-scam-case-a-justice-day-for-bihar-bjp-1896017>.

[17] Hussain, Yasir. Corruption Free India. Vol. 2. Epitome, 2012. 298. Print.

[18] Ojha, Sanjay. “Former RJD MP RK Rana Convicted in Multi-crore Fodder Scam.” Times of India 31 May 2013. 31 May 2013. Web. 2 July 2014.

[19]  Kumar, Praveen. Policing the Police. AUTHOR, 2000. 156. Print.

[20] “Former UTI Chief Subramanyam Gets Bail.” Times of India 7 Aug. 2001. 7 Aug. 2001. Web. 6 July 2014. <http://timesofindia.indiatimes.com/business/india-business/Former-UTI-chief-Subramanyam-gets-bail/articleshow/170451679.cms>.

[21] Singh, Santosh. “Verdict in Fodder Scam Case, a Justice Day for Biha.” DNA 30 Sept. 2013. 30 Sept. 2013. Web. 30 June 2014. <http://www.dnaindia.com/india/report-verdict-in-fodder-scam-case-a-justice-day-for-bihar-bjp-1896017>.

[22] Former UTI Chief Subramanyam Gets Bail.” Times of India 7 Aug. 2001. 7 Aug. 2001. Web. 6 July 2014. <http://timesofindia.indiatimes.com/business/india-business/Former-UTI-chief-Subramanyam-gets-bail/articleshow/170451679.cms>.

[23] http://129.3.20.41/eps/fin/papers/0310/0310006.pdf

[24] http://finmin.nic.in/the_ministry/dept_eco_affairs/UTI&JPC/ATRMay2003.pdf

[25] “Satyam’s Chairman Ramalinga Raju Resigns, Admits Fraud.” Times of India 7 Jan. 2009. 7 Jan. 2009. Web. 19 June 2014. <http://timesofindia.indiatimes.com/business/india-business/Satyams-chairman-Ramalinga-Raju-resigns-admits-fraud/articleshow/3946088.cms>.

[26] http://www.satyamscam.info/

[27] http://www.slideshare.net/gaurav.nemade/presentation-on-satyam-scam-by-gaurav-nemade

[28] http://www.sebi.gov.in/cms/sebi_data/attachdocs/1405419346107.pdf

[29] http://en.wikipedia.org/wiki/Satyam_scandal

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