The Ketan Parekh Financial Scandal

The Ketan Parekh Scam, which came to light in late 2001, is regarded as one of the most spectacular financial frauds in modern Indian history.

This scandal involved more than a dozen Indian financial institutions and several corporate houses and shook the very foundations of the Indian financial system.

It all started in late 1999, when Ketan Parekh, an astute trader and stockbroker, started taking large positions in many stocks, primarily in the IT and technology sectors.

Up till then, the Indian bourses were highly illiquid, and Parekh was able to manipulate the markets to his advantage.

He would buy large chunks of stocks with the help of his network of connections in various financial institutions, such as –

• Unit Trust of India (UTI)
• Industrial Development Bank of India (IDBI)
• Life Insurance Corporation of India (LIC)
• State Bank of India (SBI).

He even convinced numerous foreign institutional investors (FIIs) to invest in his ‘recommended’ stocks.

Once the stock prices started rising, Parekh and his henchmen would book profits by selling the stocks and reinvest these funds in other stocks, thereby creating a positive feedback loop which resulted in further rise in stock prices.

The new investments attracted more attention and higher volumes, which in turn caused more people to buy the stocks due to the false perception that they were gaining from the investments.

Modus Operandi

Let us look in details at how the scam operated

Creation of shell companies: Parekh used the services of hundreds of shell companies to hide his activities. These companies were set up to facilitate the manipulation of the stock market.

Manipulation of stock prices: Parekh and his associates would buy large amounts of shares in certain companies, artificially inflating their prices. They would then sell the shares when they had reached a certain price, creating huge profits for themselves.

Creating a false demand: Demand for certain stocks were falsified, by buying and selling shares quickly, creating the impression that there was increased activity in the stock. This would in turn attract more buyers and further increase the prices of the stocks.

Illegal borrowing: Illegal borrowing from banks and other financial institutions were used fund stock buying activities.

Misuse of funds: The funds obtained from the banks and financial institutions were misused for Parekh’s personal gain. They also used the money for speculative activities in the stock market.

Collusion: There were collusions with other stockbrokers to manipulate the stock market and artificially increase prices of certain stocks. Parekh also provided false information to investors in order to convince them to buy certain stocks.

How The Scam Was Exposed

The Parekh scam was exposed in late 2001, when several market-watchers noticed the sudden surge in certain stocks’ prices and volumes.

They suspected that something was amiss, as the volumes in certain stocks soared even when their fundamentals seemed weak.
In addition, the profits generated by these stocks were beyond what the normal stocks were generating.

When the Reserve Bank of India (RBI) started investigating Parekh’s activities, they realised that he had been misusing the funds of various financial institutions and corporate houses.

In fact, Parekh had been using these funds to buy up large chunks of stocks in order to manipulate the markets and generate huge profits.

The Aftermath

The most shocking aspect of the Parekh scam was its magnitude.

It is estimated that more than Rs. 40 billion (US$ 800 million) was lost in this scam, with several financial institutions and corporate houses losing most of the amount.

Under the scanner of the RBI, many other smaller players – brokers, financial institutions and mutual funds – were also brought to book.

The Indian government took a series of measures to prevent such scams from happening again. The Securities and Exchange Board of India (SEBI) imposed stricter regulations on the stock market and enforced a ban on short selling.

It also enforced a ban on derivative trading as well as a ban on portfolio management services.

In addition, the government also set up a special investigation team (SIT) to investigate the scam. The SIT found that several banks, brokers, and companies had been involved in the scam and recommended criminal action against those involved.

The Indian government also initiated a series of reforms to strengthen the capital market.

There was an increased focus on corporate governance and risk management. Banks and financial institutions were required to put in place more stringent risk management systems and corporate governance structures.

In his later years, Parekh served two years in a correctional facility in Mumbai.

While he initially pleaded guilty to the charges of market manipulation, he later contested them in the Supreme Court. In 2012, he got acquitted on the grounds of lack of evidence.

Although the Parekh scam is largely forgotten today, it still stands as a stark reminder of the power of market manipulation and the ease with which financial practices can be abused.

The scam had far-reaching consequences on India’s financial system as it exposed many loopholes and malpractices which were prevalent in the system.

As a result, the scam’s legacy still lingers in the minds of many investors, who are now more cautious about their investments.