The Ketan Parekh Fraud and Supervisory Lapses: Case Study

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Table of contents

  1. Nature and Extent of the Fraud
  2. Punishments for Fraud
  3. Conclusion

The Ketan Parekh scam was the second most important scam that shook the Bombay Stock Exchange (BSE) after the Harshad Mehta scam. Ketan Parekh was himself a mentee of Harshad Mehta and had learned stock trading from the pied piper of Bombay Stock Exchange himself. That is the reason how he was able to win the same task as compared to what Mehta himself had accomplished. When he believed of being single headedly drive the stock market, Ketan Parekh had created a 200% annual return on some stocks. The low-profile imaged Indian stock market had suddenly once again made headlines all over the world. Later it came to know that he was a broker turned operator Ketan Parekh that was running the market and not changes in the fundamentals.

A 30 member Joint Parliamentary Committee (JPC) investigation done, which found that Parekh had been involved in circular trading throughout this time period from and with various companies which includes Global Trust Bank (GBT) and Madhavpura Mercantile Cooperative bank (MMCB). The JPC found him to have played a major role in rigging up the prices of a set of ten Indian companies in short k10, from 1995 up to 2001. This resulted in Parekh's first conviction, which carried a one-year sentence, coming as a result of a transaction he conducted involving a unit of Canara Bank in 1992. Though Parekh was subsequently restricted from the stock trading, the Securities and Exchange Board of India alleged in 2009 that a variety of companies and other cine-actors were trading on behalf of Parekh. An investigation told that, and 26 entities were washed out from trading as a result of that investigation. In March 2014 he was convicted by a special CBI court in Mumbai for cheating and sentenced to two years rigorous imprisonment.

Ketan Parekh is a former stock broker resided in Mumbai, India, who was convicted in 2008, for an involvement in the Indian stock market manipulation scam that happened during the late 1998 to 2001. During this time period, Parekh in a fake manner rigged up prices of certain chosen securities (informally referred to as K-10 stocks which includes various companies), using its large sums of amount being borrowed from the banks includes the Madhavpura Mercantile Co-operative Bank, of which he himself was a director. As a result, he was banished from trading in the Indian stock exchanges till 2017.

Nature and Extent of the Fraud

Ketan Parekh had a story to back his unacceptable illegal dealings off track. He was told to be a trustee or believer of the Information, Communication and Entertainment sector that is the ICE sector. This was no special given that the fact that late 90’s and early 2000’s was the time when the IT boost had taken place, and these were the stocks which were grown by leaps worldwide. Hence, it seemed to appear that the stocks Ketan Parekh was picking were growing because of their fundamentals. The strong heavy and tremendous 200% growth in his shares was therefore not as effective and did not attract as much attention as Harshad Mehta’s escapades did.

However, Ketan Parekh was looking forward out for the stocks which has got a low market capitalization and less liquidity. He would then pump up the money into these shares and start fictional, imaginary, artificial trading within his own chain of companies. The average person may begin to believe that his stocks were increasing, and they would start investing so that it drives the prices even higher. Then, as the market took over Ketan Parekh would liquidate his holdings slowly, once again making less noise than his head Harshad Mehta would have done.

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Ketan Parekh used a theory that is modus operandi repeatedly for 10 stocks which he had picked. These stocks came to be known as the K-10 stocks and the market always seemed to be bullish and strong about the future of these stocks. The problem with Ketan Parekh’s dealings was divided into two aspects:

  1. He had accepted money from the promoters of many companies to take their share prices rise up. This can be seen as an insider trading and by itself was enough to throw Ketan Parekh into terrible trouble.
  2. However, to top it over, Ketan Parekh had also embezzled large amounts of cash from the Madhavapura Mercantile Commercial Bank (MMCB). He was believed to have bribed the officials of the said bank to persuade them to lend against shares to a greater extent than was permitted by law. At first, the bank had overcome its prescribed limits to lend against market securities as it extended credit to Ketan Parekh. Then, the bank basically started making unsecured loans to him. The loans would be sanctioned first and the collateral had been collected a few days passed by making the loans unsecured for the interim duration.

Act or course of deception, an intentional concealment, omission, or perversion of truth, to gain unlawful or unfair advantage, induce another to part with some valuable item or surrender a legal right, or inflict injury in some manner. Wilful fraud is a criminal offense which calls for severe penalties, and its prosecution and punishment (like that of a murder) is not bound by the statute of limitations. However, incompetence or negligence in managing a business or even a reckless waste of firm's assets (by speculating on the stock market, for example) does not normally constitute a fraud. In such cases, the aggrieved party (creditors or stockholders/shareholders) must prove that at some point they were intentionally deceived on a material fact.

Punishments for Fraud

Without prejudice to any liability including repayment of any debt under this Act or any other law for the time being in force, any person who is found to be guilty of fraud [involving an amount of at least ten lakh rupees or one per cent. of the turnover of the company, whichever is lower] shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud.

Provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than three years. Provided further that where the fraud involves an amount less than ten lakh rupees or one per cent. of the turnover of the company, whichever is lower, and does not involve public interest, any person guilty of such fraud shall be punishable with imprisonment for a term which may extend to five years or with fine which may extend to fifty lakh rupees or with both.

For the purpose of this section:

  • 'fraud” in relation to affairs of a company or any body corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss.
  • “wrongful gain” means the gain by unlawful means of property to which the person gaining is not legally entitled.
  • “wrongful loss” means the loss by unlawful means of property to which the person losing is legally entitled.

Conclusion

The Ketan Parekh fraud showcases the conflicting interests between various parties, brokers, bankers, auditors and corporate entities and indulges the need to have a financial and market discipline. It renews the argument that banks should operate with limited levels of risk, capital and reserves and should be subject to a more effective and accurate regulatory regime.

The supervisory lapses the Reserve Bank of India (RBI) have exposed the vulnerability of banks when they operate with a high leverage, opening themselves to a possible 'run' in the event of public concern for the banks' solvency. The fraud reiterates the fact that the banking functions now have broader ramifications and a failure of the banking system can, in turn, de-stabilise the entirety of the financial system. It makes a strong case to regulate the whole of banking transactions rather than only banks as deposit taking institutions. It becomes imperative, therefore, for the soundness of the banking system, the stability of the financial system and the safety of the depositors to put in place a more effective and comprehensive legislative enactment that would pre-empt and prevent the incidence of such large value frauds.

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