KETAN-PAREKH SCAM

Ketan-Parekh Scam was one amongst the

various White collar crimes/frauds that happened
in our country when considered broadly.
WHAT IS A SCAM?

1.A scam is something scheming and crafty done for the

sake of obtaining more money usually in malicious ways.
-Getting PHC certificate to scale up your pay (salary).

2. Fraud on the other hand is a breach of trust and

confidence for many reasons, money being one
amongst various other reasons.
-Getting PHC certificate despite not being a handicap
to have an advantage in educational purpose.
 Introduction on Corporate Frauds/White-Collar Crimes

White Collar Frauds refer to financially motivated non-violent crime committed

by business and government professionals.

According to the Federal Bureau of Investigation, white-collar crimes are

estimated to cost the United States more than $300 billion annually.

White collar crimes have become a big part

of independent business in recent times.
 HOW IT STARTS?
Those who become white collar criminals generally start their career in good

neighbourhoods and good homes, well educated with some idealism.

Get into peculiar business situations in which criminality is practically a routine way of

life.

Foresighted persons belonging to the prestigious group of society. These are indirect,

anonymous, impersonal and difficult to detect.

 WHY?

GREED & SOCIAL STATUS ISSUES

With the growing materialism all around the world acquisition of more and

more wealth has become the final end of human activity.

Consequently, moral values have either changed or thrown to winds.

And frauds, corruption, evasion of tax etc. have become the techniques of

trade, commerce and profession.

 ANY USUAL PATTERN?

A 12 Step path:

1. When the individual is given a position of power- KP belonged to a family of brokers.

2. When the person realizes they have power that they can use for their own financial benefit-

Advantage to obtain more loan under badla system and other companies because of his

reputation.
3. Other powerful people in the organization (referred to as drivers) turn a blind eye or condone

the abuse of power- Banks overlooked their capital controls and risk for KP.

4. Other passive observers become caught up in the activity because they realize that it offers

them an opportunity to make money- Many other brokers work together with KP.

5. Other more reluctant participants are drawn in by their superiors

at this stage.
6. Distrust of those involved in the activity starts to arise- The newly joined brokers and banks

start doubting KP.

7. The perpetrator recognizes his ability to exploit those in a vulnerable position within the

company- KP blackmailed officials of Bank of India.

8. The group uses bullying tactics instep 8in order to protect their illegal activities- KP

blackmailed officials of Bank of India.

9. Addiction to the illegality of their activities and willingness to take bigger and bigger risks- KP

borrowed more money to still rise the prices despite the bear trend in the end.
10.Participants in the illegal activity begin to have ethical

doubts about their behaviour- The banks in this case.

11. Fraud comes out in the open when a whistle-blower gets

the courage to reveal what has been going on. The

perpetrator loses their control over the situation- Bank Of

India.

Ends with the perpetrator either admitting to their

illegal actions, and asking for forgiveness, or trying

to deny their involvement despite mounting

 ANY WAY TO IDENTIFY SUCH CRIMES?

UNFORTUNATELY NO

We cant identify when theyve started but we can see a pattern that
they reveal themselves usually at the beginning stages of a bear
market leading it further into a recession if the impact of the fraud is
too high.

We can just learn and try correcting our system to try functioning
efficiently until another fraud comes up exploiting another loop-hole in
the system.

Frauds are one way in which markets correct themselves.

 OBJECTIVES OF THIS
STUDY
To highlight the Ketan Parekh Scam portraying the
sequence of events the key parties involved, and
major follow-up actions under taken in India.

What lessons can be learned from Ketan Parekh

scam?
THE KETAN
PAREKH SCAM A Mumbai based stock broker
chartered accountant by profession.
KP took advantage of low liquidity
in certain stocks which later came
to be known as K-10 Stocks (KP
Index).
Held significant stakes in the K-10
companies.
The buoyant stock markets from
January to July 1999 helped the K-
10 stocks increase in value
substantially.
As a result other brokers and fund
managers started investing heavily
in these stocks.
 THE K-10
STOCKS
Aftek
Infosys All my lifetime's savings are gone. I
don't know how to feed my
DSQ software
family."
Global telesystems
- A small investor hit by the Ketan
Himachal Futuristic Parekh scam, in April 2001.
Communications
Pentamedia Graphics
Satyam computers
SSI
Zee Telefilms
Pritish Nandy
Communications
Zee telefilms went up from Rs. 127 to Rs.
2330, Himachal Futuristic Rs. 194 to
2553 .
Currently he has been debarred from
trading in the Indian stock exchanges till
2017.
He was trainee of Harshad Mehta.
Ketan Parekh can be best described as the
Pied Piper of Dalal Street
Parekh came from a family of brokers which
helped him to create a trading ring of his
own.
Impact on Stock
Exchanges
 The Bombay Stock Exchange witnessed one of the worst bear runs leading to a 177-
point crash on 2 March 2001 after its gain of 177 points on 28 February 2001 in
response to the Union Budget of 2001-02.
This was due to global economic slowdown, significant market capitalization erosion at
NASDAQ and other leading stock exchanges and bear hammering on Indian stock
exchanges.
The sharp fall of prices resulted in a huge depletion in the margins on the shares that
were placed as securities.
Instead of pledging more shares or returning some borrowed money, Parekh was still
trying to prop the prices by pumping the money into the capital market.
 As the trading at CSE(Calcutta Stock Exchange) is mostly cash badla market, then as
the badla rates shot up to 80 percent, Parekh couldnt prop the prices anymore and
defaulted on payment to Kolkata brokers which resulted in payment crisis in Lyons
Range (CSE) between 12-17 March.
Ketan Parekhs Badla payments of about Rs 5-6 Billion were not honoured on time for
settlement and 70 CSE brokers defaulted on their payments.
SEBI has taken a series of rapid-fire actions to contain the crisis. It banned short sales
to checkmate bears, slapped volatility margins to rein in the bears, suspended
elected broker-directors from BSE to prevent them from misusing inside information.
It sacked 40 brokers from CSE and barred a number of brokers from carrying out their
business.
 With the rumours of another payment crisis on 8 March, stock market again fell by
268 points between 8 March and 13 March.
Ketan Parekh was arrested on 30 March 2001 which was the result of Bank of Indias
complaint to CBI, which made BSE SENSEX plunge from 3751.56 to 3604.38 points.
The benchmark index has declined from 4271.65 to 3566.26 between 1 March, 2001
and 2 April, 2001.
Badla System
 Why Badla??

It was carry forward system in place as a

borrowing route for investors in the market.

It was invented by BSE with an intention of

solving the perpetual lack of liquidity in the
secondary market.
 Some History

Had been running for decades before it was first banned in 1993 amid speculations of
it being replace by futures and options exchange which did not come around.

Badla system raised its head again in 1996 before being finally scrapped in the year
2000-01.
 The Mechanism

Basically buying stocks with borrowed money.

Person A wants to go long on a stock, doesnt have enough
money though!
Person B has funds and wishes to lend. (called Badla financer)
Person A can enter a Badla transaction with the Exchange acting
as an intermediary between A and B and go long on the stock
he wishes to.
After a certain period of time A has to repay B an amount which is
higher than what he borrowed this is analogous of interest. (lets
call it Badla Interest).
The Fine print:

Badla interest determined by the exchange depending

upon the demand for the underlying stock in the Badla
transaction.
The maximum position of an open Badla transaction
was 70 days, i.e the borrower had to repay his loan
and couldnt carry it forward beyond 70 days.
Carry forward limit as imposed in 1996 was Rs. 200M
per broker i.e the broker could not have an open Badla
position exceeding Rs. 20 Cr at any point in time.
The Scam:

KP handpicked low liquidity stocks, HFCL, Global Telesystems (Global), Zee Telefilms,
Crest Communications and a few others which later were collectively called K-10
stocks. Typically the ones with low trading prices.
KP then borrowed money from MMCB(Madhavpur Mercantile Corp Bank) and various
other institutions and started buying significant quantities in the K-10 stocks at
regular intervals.
Owing to the low liquidity these periodic investments would drive these stocks up
really quickly, this created a buzz around these stocks and attracted more
investors both retail and institutional to invest in these stocks further inflating the
stock prices.
HFCL soared by 57% while Global increased by 200%.
Contd

Meanwhile KP owing to his influential contacts, built an

extremely robust and well knit network of brokers who were
willing to borrow on his behalf from the various banks and
Institutions whose chairmen and top management were
already in on the scam alongside KP.
Now came the part where the stocks he was invested in had
risen significantly, now he would pledge a portion of these
overvalued securities to raise more funds from different
sources.
MMCB was the frontrunner when it came to lending to KP
and his associates, it had breached all capital exposure limits
to pump money into this scheme.
 Contd

This cycle continued, every time KP would pledge overvalued shares and borrow money
to rig the price of more and more stocks and gullible investors how were under the
influence of riding the DotCom boom thought these stocks were bound to keep going up
for a foreseeable future, hence they stay put in the K-10 stocks.

KP now decided to burst the bubble by offloading huge amounts of these stocks and the
retail investors were caught on the wrong foot as the stock prices tumbled so fast they
hardly had any time to close their positions.
Detection
 Ketan Parekh brought shares when they were trading at a low price and
saw the price go up in bull market.

When the prices were high enough, he pledged the shares as collateral
to the banks for loan.

Main accomplice- Madhavpur Mercantile Cooperative Bank

gave large amount of money without proper
collateral
 Dot-Com bubble burst in 2000 saw the K-10 shares fall rapidly.
While NASDAQ fell by 35.9% and SENSEX by 23%, K-10 stocks fell by
67%.
KP was asked to either repay the loan or keep more shares as collateral.
Bear Hammering of K-10 stocks lead to payment problems for KP.
This was followed by the payment problems in Calcutta Stock Exchange
which was critical to KPs operations.
 The value of stocks held by CSE brokers decreased by around Rs.6
billion

Another payment to KP of Rs.5-6 billion dollars on Badla payment was

not honoured creating further problems.

All this lead to a stock market crash of 176 points immediately the next
day following the 2001 budget which saw SENSEX shoot up by 177
points.
 This prompted SEBI to order investigation into the books of several brokers
under suspicion.

RBI also ordered investigation into banks after reports that banks had not
followed proper procedures while lending money to KP.

BSE president Anand Rathis resignation on charges of divulging sensitive

information created further problems.

On March 30, 2001 KP was arrested on several charges, one being

defrauding Bank of India of $30 million.
Factors that helped him

Ketan Parekh bought shares when they were

trading at low price and saw the prices go up in the
bull market while continuously trading.

When the prices were high enough, he pledged the

shares with banks as collateral for funds, and also
borrowed from the companies like HFCL.

It could not have been possible without the

involvement of banks.
 A small Ahmedabad-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 orderroute, 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.
As per a RBI inspection report, MMCB's loans to
stock markets were around Rs 10 billion of which
over Rs 8 billion were lent to KP and his firms.
 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 reportedly used his BoI accounts to discount 248 pay
orders worth about Rs 24 billion between January and
March 2001. BoI's losses eventually amounted to well
above Rs 1.2 billion.
Circular Trading

A fraudulent trading scheme where sell orders are

entered by a broker who knows that offsetting buy
orders, the same number of shares at the same time
and at the same price, either have been or will be
entered.

These trades do not represent a real change in the

beneficial ownership of the security.
Systemic Flaws

CSE`s erroneous method of calculating trading exposure limits ,

excluding the long positions.
Margin money collected by the CSE on gross exposure was lower than
the required.
CSE had appointed all the 9 broker Directors as honorary treasurers and
authorized them to operate all the bank accounts signed by any two of
them.
 Role of CSE
Collecting and holding margins in the form of cheques instead of
debiting brokers account.

Brokers are extremely savvy about their rights and never allowed
inspectors of one stock exchange to follow audit trails.
This coupled with the open outcry system for the start of the scam
made the retrieval of records and surveillance very difficult.
Role of CSE (Contd..)

Stock exchanges are not yet adequately equipped with the fully
functional stock watch system.

SEBI has not been able to fully investigate the fund flows and the extent
of involvement of houses even though NSE has emphasised in its
reports.
The culprit : Non-uniform
settlement periods.
The system of differing settlement periods played a big part in
masking concentrated trading positions across exchanges.

Since brokers rolled their large trading positions between the CSE,
NSE and BSE and others, it was impossible for stock exchanges to
assess systemic risk beyond the trading positions on their own
exchanges.
Implications from this Scam

One of the biggest Fall in BSE -700 points

BOI complains to CBI-Ketan Parekh is arrested

Ketan Parekh was arrested by CBI on 30 th March 2001. He was charged

defrauding Bank of India by almost $20 Million

Ketan Parekh and other traders were banned from trading for 17 years

Short selling was banned for 6 months.

Badla system was banned

All shares that were put as collaterals should be done so through NSE and BSE.

Options and Index Future derivatives was introduced

10% additional deposit Margins.

 RBI ordered some banks to furnish data of Capital market exposure
SEBI inspected the books of several brokers suspected of triggering the
crash
Global Trust Bank and Bank of India 's merger failure
SBI's loss was minimal. So it did nothing
MMTC was liquidated ; KP paid its stockholders Rs.400 Crores.
He still owes them Rs. 400 Crores
 The Governments liberalization policies came under severe criticism
Subsequently, these policies were put on hold for a while
SEBI, the securities market regulator, postponed sanctioning of private
sector mutual funds
The entry of much talked about foreign pension funds and mutual funds
became the remotest possibility
The Euro-issues planned by many Indian Cos. Were delayed
SEBIs role after the
Scam
 SEBI launched immediate investigation on the scam.
It suspended all the broker member directors of BSES governing board
SEBI also banned trading by all stock exchange presidents, vice
presidents and treasurers
SEBI banned naked short sales.
RBI started inspecting accounts and sub-accounts twice a year in spite
of once in two year.
 SEBI allowed banks for collateralised lending only through BSE and NSE
An additional 10% deposit margin was imposed on outstanding net sales
in the stock markets
The limit of application of the additional volatility margins was lowered
from 80% to 60%
To revive the markets SEBI imposed restriction on short sales and
ordered.
Measures post KP Scam

Trading cycle was cut short from a week to a day

The carry-forward system in stock trading called BADLA was banned
Introduced forward trading in the form of exchange-traded derivatives
Withdrew broker control over stock exchanges
Conclusions

Its a persons tendency to make money.

The shortest way to make money in stock markets is to find one
loophole in the system and capitalize on that loophole itself.
The loophole discovered by Ketan Parekh was not exactly an illegal one
but the steps taken by him made it and illegal one.
He took the advantage of his connections and blackmailed the officials
who came in his way.
Also, any illegal loophole cannot be capitalized by any person alone.
In our case, the banks, who were also a whistle blowers, were helping
him until they saw the profit in his schemes and could muster the
courage needed.
Conclusions (Contd.)

Any system that is in place right now, is not completely foolproof.

There are some flaws that exist in every system.
SEBI and other authorities like the exchanges need to be more active in
their activities and should ensure that any such loopholes are covered
completely and that any person should not be able to take the
advantage of the loophole that easily.
Hence, its a collective effort of people, traders, and watchdogs that will
make a foolproof system.
Once the system is completely free from any flaws, that is the only time
we can really say that the market is an efficient one.