HARSHAD MEHTA- THE BIG BULL
Harshad Mehta was an Indian stockbroker caught in a scandal beginning in 1992. Harshad
Shantilal Mehta was born in a Gujarati jain family of modest means. His father was a small
businessman. His early childhood was spent in the industrial city of Bombay. Due to indifferent
health of Harshad’s father in the humid environs of Bombay, the family shifted their residence
in the mid-1960s to Raipur, then in Madhya Pradesh and currently the capital of Chattisgarh
state. While doing odd jobs he joined Lala Lajpat Rai College for a Bachelor’s degree in
After completing his graduation, Harshad Mehta started his working life as an employee of the
New India Assurance Company. During this period his family relocated to Bombay and his
brother Ashwin Mehta started to pursue graduation course in law at Lala Lajpat Rai College.
After his graduation Ashwin joined (ICICI) Industrial Credit and Investment Corporation of India.
They had rented a small flat in Ghatkopar for living. In the late seventies every evening Harshad
and Ashwin started to analyze tips generated from respective offices and from cyclostyled
investment letters, which had made their appearance during that time.
In the early eighties he quit his job and sought a job with stock broker P. Ambalal affiliated to
Bombay Stock Exchange (BSE) before becoming a jobber on BSE for stock broker P.D. Shukla.
In 1981 he became a sub-broker for stock brokers J.L. Shah and Nandalal Sheth. After a while he
was unable to sustain his overbought positions and decided to pay his dues by selling his house
with consent of his mother Rasilaben and brother Ashwin. The next day Harshad went to his
brokers and offered the papers of the house as guarantee. The brokers Shah and Sheth were
moved by his gesture and gave him sufficient time to overcome his position. After he came out
of this big struggle for survival he became stronger and his brother quit his job to team with
Harshad to start their venture GrowMore Research and Asset Management Company Limited.
While a broker’s card at BSE was being auctioned, the company made a bid for the same with
financial assistance from Shah and Sheth, who were Harshad's previous broker mentors. He
rose and survived the bear runs, this earned him the nickname of the Big Bull of the trading
floor, and his actions, actual or perceived, decided the course of the movement of the Sensex
as well as scrip-specific activities. By the end of eighties the media started projecting him as
"Stock Market Success", "Story of Rags to Riches" and he too started to fuel his own publicity.
He felt proud of this accomplishments and showed off his success to journalists through his
mansion "Madhuli", which included a billiards room, mini theatre and nine hole golf course. His
brand new Toyota Lexus and a fleet of cars gave credibility to his show off. This in no time made
him the nondescript broker to super star of financial world. During his heyday, in the early
1990s, Harshad Mehta commanded a large resource of funds and finances as well as personal
WHAT WENT WRONG?
Harshad Mehta was the darling of the stock markets -- a superstar whose popularity had begun
to rival that of a matinee star. He was the cover story on several magazines and was being shot
by audio-visual newsmagazines symbolically feeding peanuts to bears at the Bombay zoo.
The fall In April 1992, the Indian stock market crashed, and Harshad Mehta, the person who
was all along considered as the architect of the bull run was blamed for the crash. It transpired
that he had manipulated the Indian banking systems to siphon off the funds from the banking
system, and used the liquidity to build large positions in a select group of stocks.
In the early 1990s, the banks in India had to maintain a particular amount of their deposits in
government bonds. This ratio was called SLR ( Statutory Liquidity Ratio). Each bank had to
submit a detailed sheet of its balance at the end of the day and also show that there was a
sufficient amount invested in government bonds. Now, the government decided that the banks
need not show their details on each day, they need to do it only on Fridays. Also, there was an
extra clause that said that the average %age of bond holdings over the week needs to be above
the SLR but the daily %age need not be so. That meant that banks would sell bonds in the
earlier part of the week and then buy bonds back at the end of the week. The capital freed in
the starting of the week could then be invested. Now, at the end of the week many banks
would be desperate to buy bonds back. This is where the broker comes in. The broker knew
which bank had more bonds (called ‘plus’) and which has less than the required amount (called
‘short’). He then acts as the middleman between the two banks. Harshad Mehta was one such
broker. He worked as a middle man between many banks for a long time and gained the trust
of the banks’ senior management. Lets say that there are two banks A (short) and B (plus). Now
what Harshad Mehta did was that he told the banker at A that he was dealing with many banks
and hence did not know who would he deal in the end with. So he said that the bank should
write the cheque in his name rather than the other bank (which was forbidden by law), so that
he could make the payment to whichever bank was required. Since he was a trusted broker, the
banks agreed. Then, going back to the example of bank A and B, he took the money from A and
went to B and said that he would pay the money on the next day to B but he needed the bonds
right now (for A). But he offered a 15 % return for bank B for the one day extension. Bank B
readily agreed with this since it was getting such a nice return
Now since Harshad Mehta was dealing with many banks at the same time he could then keep
some capital with him at all times. For eg. He takes money from A on Monday, and tells B that
he’ll pay on Tuesday, then he takes money from C on Tuesday and tells D that he’ll pay on
Wednesday and the money he gets from C is paid to B and as a result he has some working
capital with him at all times if this goes on with other banks throughout the week. The banks at
that time were not allowed to invest in the equity markets. Harshad Mehta had very cleverly
squeezed some capital out of the banking system. This capital he invested in the stock market
and managed to stoke a massive boom.
The story began to fall apart with the revelation that Harshad had helped himself to a cool Rs 5
billion from State Bank of India by making a SGL receipt vanish.
SEBI UNFLODED THE MYSTERY
It is the astounding story of an irrepressible and ambitious Harshad Mehta attempting to cock a
snook at the system, which tried to tie him down in 35-odd court cases and re-work his
charismatic magic with investors. Fortunately for Indian investors, the comeback died a quick
Harshad had made his plans carefully. He anticipated the Internet as a powerful tool and
launched his own website -- www.harshad.com to dispense stock tips and analyse market
trends. A set of media managers then set him up with columns in several leading newspapers.
The next step was to convince a set of companies to collaborate with him in ramping up their
prices and find several legitimate brokers to put through his trades.
Sebi's investigation reveals that a set of brokers was happy to deal with these unknown
companies with no financial standing or professional expertise and without taking any security
or deposit, only because of their faith in the Harshad Mehta magic. BPL, Videocon and Sterlite
were lured by Harshad's sales pitch and by February 1998, the market was buzzing about the
return of the Big Bull. Sebi's investigations show that from April to June 4, 1998, BPL, Videocon
and Sterlite's scrip prices moved up 137 per cent, 232 per cent and 41 per cent respectively,
even while the bellwether BSE Sensex declined 11 per cent due to various domestic and
But April 1998 was very different from April 1992. Harshad had limited access to funds, his
trading cards were suspended. More importantly, he needed to create a large network of front
companies to do his business. Sebi refers to these as the Damayanti Group. The companies
included Damayanti Finvest, CDP Fincap and Leasing, KRN Finvest and Leasing, Rijuta Finvest
and Ikshu Finvest which operated through a set of brokers and sub-brokers who did Harshad's
All these companies had the same address: 1208 Maker Chambers V, Nariman Point, Bombay
400 021 -- once famous as Harshad's nerve centre and the office of Growmore Research &
Asset Management Ltd.
He also started another set of companies in keeping with his plans. They were Money Television
Industries, Esquire International, Starshare Investment and Finanz, Stable Constructions and
New Prabhav Finvest.
The Damayanti group began to face payment difficulties and papered this over by rolling their
positions from one bourse to another and transferring positions among brokers though a
system of kaplis or credit notes. (This was a loophole for manipulation, which has since been
Sebi says the Bombay Stock Exchange, which was perfectly aware about Harshad's shenanigans,
not only failed to take "effective surveillance measures", but also lowered margins in these
scrips and later tried to bail him and his brokers out by arm-twisting companies to cover the
payment default. They also opened the trading system in the middle of the night to insert
synchronised trades at prices that were completely out of line with the day's trading.
When the payment crisis hit the market, it was common knowledge that Harshad had gone
broke. Newspapers wrote about it, but Sebi's job was to track his front companies and to link
them to him. That was a tough proposition, since Sebi has limited powers of search and seizure.
At every stage, Harshad's people fudged their answers, refused to co-operate and tried to cover
their tracks. Yet, the 1999 investigation was complete.
Sebi found that four persons -- Anil Doshi, Dinesh Doshi, Dilip Shah and Vinod Shah -- were
directors of the Damayanti group in various permutations and combinations. The first two were
his wife's brothers. The latter two claimed they were just salaried employees and had carried
out orders. Pankaj Shah, Sunil Samtani and Atul Parikh, who were co-accused with Mehta in
1992, were also an important part of the front operators.
After searches at the Damayanti offices, Sebi established links to Harshad through telephone
bills, payment to lawyers, investment details and brokers such as LKP Securities and Digital
Travel bills found at Harshad's office were key to linking the Mehtas. Though the bills and
invoices of the two travel agencies -- Taurus Travels and Bonik Travels -- were fudged to show
purchases in the names of company employees, Sebi managed to verify through the airlines
that it was Harshad Mehta, his family and associates who had actually traveled on the tickets.
It also found payments to the tune of Rs 1.4 million made from the front companies to
Harshad's lawyers Mahesh Jethmalani, S D Jaisinghani, and Chougle & Co when they had sought
no legal advice from them.
Sebi also tracked telephone calls from the Damayanti group to senior BPL executives such as its
director T C Chauhan, who admitted he had made the calls to Harshad at the Damayanti group
Sebi hit pay dirt when it found a document from the Damayanti office which listed details of
investments of Rs 1.46 billion in BPL, Videocon and Sterlite in the second week of June, which
pertained to the BSE and NSE settlements of that period.
The document also connected Harshad Mehta's activities to a series of brokers -- El Dorado
Guarantee, Dil Vikas Finance, LKP Securities, Madhukar Sheth, Sony Securities and GNH Global
Securities. Of these, Madhukar Sheth and LKP have figured prominently in the 2001 debacle
S S Gulati of LKP Shares and Stockbrokers and Digital Leasing, which had tried to recover money
from Harshad Mehta, provided further corroboration. Shrenik Jhaveri and Bharat Khona were
two other brokers who informed Sebi that Harshad had delivered a large quantity of BPL shares
to them through the front companies in lieu of old liabilities.
The key to Mehta's market manipulations were his dealings with BPL, Videocon and Sterlite
which were finally barred last week from accessing the capital market for four, three and two
Sebi discovered that these companies lent Harshad the initial money to build up concentrated
position in these counters. The outstanding purchases were particularly heavy at the end of
each settlement period in order to provide price benchmarks for the next settlement. In fact, at
one stage the brokers operating in BPL for the Damayanti group accounted for 70 per cent of
the total outstanding position of the scrip on the BSE -- a clear indicator that the BSE was
studiously turning a blind eye to their activities.
Interestingly, another set of brokers operating on the NSE took delivery of 70 per cent of the
total delivery for BPL in settlement no 22 of 1998 -- indicating how positions were rolled over
from on bourse to another. Exactly the same operation was replicated in Videocon and Sterlite
Having established that the Damayanti Group was set up by Harshad Mehta, the rest was easy.
The three corporate houses did not even cover their tracks as we show in the next two parts. As
Sebi points out, such cornering of shares and price manipulation created an artificial market
that ultimately led to the collapse and was detrimental to the interest of investors in general.
When the scam broke out, he was called upon by the banks and the financial institutions to
return the funds, which in turn set into motion a chain reaction, necessitating liquidating and
exiting from the positions which he had built in various stocks.
The panic reaction ensued, and the stock market reacted and crashed within days. He was
arrested on June 5, 1992 for his role in the scam. His favorite stocks included
• Apollo Tyres
• Tata Iron and Steel Co. (TISCO)
The extent The Harshad Mehta induced security scam, as the media sometimes termed it,
adversely affected at least 10 major commercial banks of India, a number of foreign banks
operating in India, and the National Housing Bank, a subsidiary of the Reserve Bank of India,
which is the central bank of India. As an aftermath of the shockwaves which engulfed the Indian
financial sector, a number of people holding key positions in the India's financial sector were
adversely affected, which included arrest and sacking of K. M. Margabandhu, then CMD of the
UCO Bank; removal from office of V. Mahadevan, one of the Managing Directors of India’s
largest bank, the State Bank of India.
The end The Central Bureau of Investigation which is India’s premier investigative agency, was
entrusted with the task of deciphering the modus operandi and the ramifications of the scam.
Harshad Mehta was arrested and investigations continued for a decade. During his judicial
custody, while he was in Thane Prison, Mumbai, he complained of chest pain, and was moved
to a hospital, where he died on 31st December 2001. His death remains a mystery.
Some believe that he was murdered ruthlessly by an underworld nexus (spanning several South
Asian countries including Pakistan). Rumour has it that they suspected that part of the huge
wealth that Harshad Mehta commanded at the height of the 1992 scam was still in safe hiding
and thought that the only way to extract their share of the 'loot' was to pressurise Harshad's
family by threatening his very existence. In this context, it might be noteworthy that a certain
criminal allegedly connected with this nexus had inexplicably surrendered just days after
Harshad was moved to Thane Jail and landed up in imprisonment in the same jail, in the cell
next to Harshad Mehta's. Mumbai: Just as the year 2001 was coming to an end, Harshad
Shantilal Mehta, boss of Growmore Research and Asset Management, died of a massive heart
attack in a jail in Thane.
And thus came to an end the life of a man who is probably the most famous character ever to
have emerged from the Indian stock market. In the book, The Great Indian Scam: Story of the
missing Rs 4,000 crore, Samir K Barua and Jayanth R Varma explain how Harshad Mehta pulled
off one of the most audacious scams in the history of the Indian stock market. Harshad
Shantilal Mehta was born in a Gujarati Jain family of modest means. His early childhood was
spent in Mumbai where his father was a small-time businessman. Later, the family moved to
Raipur in Madhya Pradesh after doctors advised his father to move to a drier place on account
of his indifferent health.
The Bernard Madoff scam
Bernard Lawrence "Bernie" Madoff (born April 29, 1938) is an incarcerated
former American stock broker, investment adviser, non-executive chairman of
the NASDAQ stock market, and the admitted operator of what has been described as the
largest Ponzi scheme in history. Madoff was born into a Jewish family, Ralph and Sylvia
(née Muntner) Madoff in the New York City borough of Queens, on April 29, 1938. Madoff
graduated fromFar Rockaway High School in 1956, attended the University of Alabama for one
year, where he became a brother of the Tau Chapter of the Sigma Alpha Mu fraternity, then
transferred to and graduated from Hofstra College in 1960 with a B.A. in political science. In
1959, Madoff married Ruth Alpern, who graduated from Queens College and worked in the
stock market in Manhattan. She later worked in Madoff's firm, and founded the Madoff
Madoff founded the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960. He
was its chairman until his arrest on December 11, 2008.
The firm started as a penny stock trader with $5,000 ($36,731 in current dollar terms) that
Madoff earned from working as a lifeguard and sprinkler installer. His business grew with the
assistance of his father-in-law, accountant Saul Alpern, who referred a circle of friends and their
families. Initially, the firm made markets (quoted bid and ask prices) via the National Quotation
Bureau's Pink Sheets. In order to compete with firms that were members of the New York Stock
Exchange trading on the stock exchange's floor, his firm began using innovative computer
information technology to disseminate its quotes. After a trial run, the technology that the firm
helped develop became the NASDAQ.
The firm functioned as a third-market provider, which bypassed exchange specialist firms, by
directly executing orders over the counter from retail brokers. At one point, Madoff Securities
was the largest market maker at the NASDAQ and in 2008 was the sixth largest market maker
on Wall Street. The firm also had an investment management and advisory division, which it
did not publicize, that was the focus of the fraud investigation.
Madoff was "the first prominent practitioner of payment for order flow, in which a dealer pays
a broker for the right to execute a customer's order. This has been called a "legal kickbac
HOW IT WORKED
Every great scheme needs a cover story in order to shield it from scrutiny. With something like
the Madoff Ponzi scheme however, the cover story is vitally important because of the
absolutely ridiculous returns that Madoff was generating through the processes that eventually
resulted in the Madoff scandal in 2008. A Ponzi scheme is a type of fraud that is a really simple
investing scheme. An investment company or investment manager promises potential clients a
high return on their investments with low risk.
From 1982 to 1992, Madoff Securities was able to generate a return to its clients of more than
15% per year. That is something that ended up catching the attention of a number of people
that in turn started interviewing him in different media outlets. Madoff deflected attention
from this particular story by pointing out that the S&P 500 index actually generated an average
return per annum of 16.3% over the course of the same period of time.
In the financial world, an arbitrage situation is one wherein a person invests in multiple
outcomes with the knowledge that those outcomes allow you to make a profit no matter which
way the market turns. They are essentially can’t lose propositions and according to Madoff, he
knew about a lot of them and used them in order to generate the returns that he was later able
to give back to his clients.
It is this ruthless and cold-blooded premeditation with billions of dollars that has made him one
of the most hated people in the modern financial world. Because of that, he will also be a
person that is talked about quite a bit as time goes on.
Madoff pretended he was running a legitimate financial business when in reality he was putting
together one of the greatest Ponzi schemes of all time. The investigators that believe he had
been in the illegal active ties at least in part since the 1970s, there are grounds to be very
worried about how the different parts of the regulatory framework of the financial system
within the United States are working.
There was a report released in 2007 by the Financial Industry Regulatory Authority that actually
pointed out that Madoff Securities had different sections that did not seem to service any
customers. At the same point in time, there were various red flags about the way in which
Madoff was doing business that did seem to alert many of the other outside agencies as to the
fact that fraud of some kind might be going on in his firm.
One reason that has been put forward regarding the Madoff scandal being so successful for so
long is that a lot of people did not really want to mess with Bernie Madoff. Another thing that
people point to is the almost incestuous relationship that Madoff’s family had with
Washington. There were multiple instances over the course of time when legislation that
would have helped Madoff maintain his veil of secrecy over the operations of his firm was
passed. He definitely had a lot of beneficial non-regulation thrown his way. Whether that was
because of his family’s relationship to Washington or just coincidental is another point of
debate for many people.
Many large clients like Union Bancaire Privee and Fairfield Greenwich Group claimed that after
taking a close look at his business practices, they did not see anything unusual with the way in
which he did his business. By promising modest rather than overwhelming returns to that
smaller number of larger clients, Madoff was able to run his Ponzi scheme with a slightly higher
health level since the percentage gain that he was required to pay out to each successive
person was a bit smaller.
THE FALL OF THE GIANT
There were ample signs that Madoff's operation was fraudulent. He made his reputation and
his millions by delivering solid returns of 1 or 2 percent a month to his investors month in and
month out from the day he launched his investment advisory business as an adjunct to his
brokerage firm. Wealthy investors and hedge fund operators marveled as Madoff worked his
"magic" in bull markets and bear markets alike, regardless of the gyrations on the stock market.
It started with an inkling that the downturn in the stock market was on its way. As the
economy started to get worse, the Democratic candidate started to go up in the polls. This is
relevant because eventually it was Bernie Madoff that ended up becoming the poster boy for
the terrible shape in which the regulatory framework of the government was.
The returns from the stock market were able to allow Madoff to keep his Ponzi scheme going,
but when the stock market started to unravel it became pretty obvious that Madoff was
definitely in deep trouble.
His $17 billion investment advisory business was "a giant Ponzi scheme," continue to widen.
According to a criminal complaint filed by the FBI and a civil action brought by the Securities
and Exchange Commission (SEC), the elderly Madoff estimated that the losses from his fraud
exceeded $50 billion. The tally of losses already reported by banks, hedge funds and wealthy
investors climbed over the weekend to nearly $20 billion.
Banks and hedge funds around the world—in the US, Britain, Italy, Spain, France, Switzerland
and Japan—are reporting hundreds of millions and even billions in losses. University
endowments, charities and other institutions that entrusted their money to Madoff or to hedge
funds that invested in Madoff's company are reeling from the news that their investments are
The largest victim of Madoff’s scheme was probably the Fairfield Greenwich Group, with
around $7.3 billion invested in over 15 years. During this entire time, Madoff gave them an
annual return which was over the regular interest rates by 4 to 6 percent. HSBC was another big
victim of Madoff’s Ponzi scheme, with over $1 billion, which were loaned to clients that wanted
to invest with Madoff’s company. Santander, which is a very large European bank, invested
around $3.1 billion, while Fortis Bank and Access International invested $1.4 billion each, Union
Bancaire Privet put $1.1 billion and Tremont Capital lost a staggering $3.3 billion. Even schools
lost money to Madoff, some examples being Bard College, the New York University, the
Maimonides School and others.
Prominent and wealthy individuals—including J. Ezra Merkin, the chairman of GMAC, Fred
Wilpon, the principal owner of the New York Mets, Norman Braman, the former owner of the
Philadelphia Eagles professional football team, Frank Lautenberg, the multimillionaire
Democratic senator from New Jersey, and Mortimer Zuckerman, the owner of the New York
Daily News, Steven Spielberg, actor Kevin Bacon, the owners of the New York Mets, and others.
—are among those who have lost millions. Some of Madoff's investors are actually out on the
street, living out of cars and RV's.
Among the thousands and even tens of thousands of individuals likely to be affected is no small
number of retirees of relatively modest means whose life savings were tied into Madoff's
The fallout from the Madoff scandal will inevitably result in the failure of other investment
firms, impacting thousands more individuals and hundreds more businesses.
The returns from the stock market were able to allow Madoff to keep his Ponzi scheme going,
but when the stock market started to unravel it became pretty obvious that Madoff was
definitely in deep trouble. Over the days leading up to his arrest, Madoff attempted to get
more money from other people and use that money to pay off the existing debts that he had.
He was in full damage control mode, but after a period of time it became apparent that he was
not going to be able to go very far under the current damage control mode that he was in.
When it became obvious to Madoff that he was finished, he actually went into consolidation
mode. Forgetting about his investors entirely, Madoff tried to have bonuses paid out to the
different company employees in order to secure for his own people the funds that were still
remaining in the company. Interestingly enough, it is quite possible that Madoff might have
been successful in this scheme were it not for the fact that two unlikely candidates stopped him
dead in his tracks.
Those two candidates were his sons. Mark Madoff and Andrew Madoff were both employees
in the firm and their father came to them with the plan to pay out bonuses to the employees
from the $200 million or so that the company still possessed at the time, down from the billions
that it had been worth just a few months earlier. His sons demanded to know how he could
have come up with such a bad idea. To them, paying out bonuses to employees of the
company when the company did not even have the liquidity available to meet commitments to
its investors was the height of irresponsibility. It was at that point that Madoff was forced to
admit to them that the asset management wing of his company was nothing more than a Ponzi
scheme. Shocked to find that out, his sons immediately reported him to the authorities and
they came and arrested Madoff.
He was handed a sentence that was worth 150 years in prison. He was also ordered to pay
back $170 billion in restitution, money that might be meaningless now given the fact that he
really did not have the ability to come up with that amount of money at any point in time.
Additionally, since Madoff is already in his seventies, one would think that he might not even
get a chance to serve the first 10% of his prison term before he eventually ends up dying in
prison. That is something that will definitely happen to him, the only question really is when.
The 150 year sentence was far more of a statement than it was anything of practical
THE ENRON SCANDAL
The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron
Corporation, an American energy company based in Houston, Texas, and the dissolution of
Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the
world. In addition to being the largest bankruptcy reorganization in American history at that
time, Enron undoubtedly is the biggest audit failure.
Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth.
Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that,
through the use of accounting loopholes, special purpose entities, and poor financial reporting,
were able to hide billions in debt from failed deals and projects. Chief Financial Officer Andrew
Fastow and other executives were able to mislead Enron's board of directors and audit
committee of high-risk accounting issues as well as pressure Andersen to ignore the issues.
Many executives at Enron were indicted for a variety of charges and were later sentenced to
prison. Enron's auditor, Arthur Andersen, was found guilty in a United States District Court, but
by the time the ruling was overturned at the U.S. Supreme Court, the firm had lost the majority
of its customers and had shut down. Employees and shareholders received limited returns in
lawsuits, despite losing billions in pensions and stock prices. As a consequence of the scandal,
new regulations and legislation were enacted to expand the reliability of financial reporting for
public companies. One piece of legislation, the Sarbanes-Oxley Act, expanded repercussions for
destroying, altering, or fabricating records in federal investigations or for attempting to defraud
shareholders. The act also increased the accountability of auditing firms to remain objective
and independent of their clients.
WHAT HAPPENED TO ENRON?
The collapse of Enron caught almost everyone by surprise, from employees and investors to
analysts and creditors. But how did the seventh largest company in the Fortune 500 plummet
into bankruptcy and implode so quickly?
The Enron story comes in three stages
Stage 1: The Company leveraged itself through debt, which it used to grow its non-
core wholesale energy operations and service business. Some of this debt was
reportable on the company's balance sheet, and some was not. No problem for the
company, as long as the stock price held up.
Stage 2: The stock price fell. When that happened, off-balance-sheet liabilities put
pressure on debt agreements, and eventually led to credit downgrades.
Stage 3: The margins in this business are very thin and lower credit quality increased
Enron's cost of borrowing to the point where the whole company fell into a liquidity
Movement of Enron’s share price (USD):
Enron's stock price, which hit a high of US$90 per share in mid-2000, caused shareholders to lose nearly
$11 billion when it plummeted to less than $1 by the end of November 2001. The U.S. Securities and
Exchange Commission (SEC) began an investigation, and Dynegy offered to purchase the company at a
fire sale price. When the deal fell through, Enron filed for bankruptcy on December 2, 2001 under
Chapter 11 of the United States Bankruptcy Code, and with assets of $63.4 billion, it was the largest
corporate bankruptcy in U.S. history until WorldCom's 2002 bankruptcy.
As the energy markets, and in particular the electrical power markets were deregulated,
Enron’s business expanded into brokering and trading electricity and other energy
The deregulation of these markets was a key Enron strategy as it invested time and money in
lobbying Congress and state legislatures for access to what traditionally had been publicly
provided utility markets. Some of Enron’s top executives became frequently named corporate
political patrons of the Republican Party. Enron needed the federal government to allow it to
sell energy and other commodities. According to the Center for Responsive Politics, between
1989 and 2001, Enron contributed nearly $6 million to federal parties and candidates
It was one of the first amongst energy companies to begin trading through the Internet,
offering a free service that attracted a vast amount of customers. But while Enron boasted
about the value of products that it bought and sold online – a mind-boggling $880bn in just two
years – the company remained silent about whether these trading operations were actually
making any money. At about this time, it is believed that Enron began to use sophisticated
accounting techniques to keep its share price high, raise investment against it own assets and
stock and maintain the impression of a highly successful company. Enron's 2000 annual report
reported global revenues of $100bn. Income had raised by 40% in three years.
Enron’s complex business model—reaching across many products, including
physical assets and trading operations, and crossing national borders—stretched
the limits of accounting.6 Enron took full advantage of accounting limitations
in managing its earnings and balance sheet to portray a rosy picture of its
Two sets of issues proved especially problematic. First, its trading business
involved complex long-term contracts. Current accounting rules use the present
value framework to record these transactions, requiring management to make
forecasts of future earnings. This approach, known as mark-to-market accounting,
was central to Enron’s income recognition and resulted in its management making
forecasts of energy prices and interest rates well into the future. Second, Enron
relied extensively on structured . Finance transactions that involved setting up special
purpose entities. These transactions shared ownership of specific cash flows and
risks with outside investors and lenders. Traditional accounting, which focuses on
arms-length transactions between independent entities, faces challenges in dealing
with such transactions. Accounting rule-makers have been debating appropriate
accounting rules for these transactions for several years. Meanwhile, mechanical
conventions have been used to record these transactions, creating a divergence
between economic reality and accounting numbers.
Enron’s accounting problems in late 2001 were compounded by its recognition
that several new businesses were not performing as well as expected. In
October 2001, the company announced a series of asset write-downs, including
after tax charges of $287 million for Azurix, the water business acquired in 1998,
$180 million for broadband investments and $544 million for other investments.
In addition, on October 5, 2001, Enron agreed to sell
Portland General Corp., the electric power plant it had acquired in 1997, for
$1.9 billion, at a loss of $1.1 billion over the acquisition price. These write-offs and
losses raised questions about the viability of Enron’s strategy of pursuing its gas
trading model in other markets.
In summary, Enron’s gas trading idea was probably a reasonable response to
the opportunities arising out of deregulation. However, extensions of this idea into
other markets and international expansion were unsuccessful. Accounting games
allowed the company to hide this reality for several years. Capital markets largely
ignored red gas associated with Enron’s spectacular reported performance and
aided the company’s pursuit of an awed expansion strategy by providing capital at
a remarkably low cost. Investors seemed willing to assume that Enron’s reported
growth and pro. Stability would be sustained far into future, despite little economic
basis for such a projection.
The market response to the announcements of accounting irregularities and
business failures was to halve Enron’s stock price and to increase its borrowing
costs. For a company that had relied heavily on outside finance to fund its trading
businesses and acquisitions, the results were equivalent to a run on the bank. On
November 8, 2001, Enron sought to avoid bankruptcy by agreeing to being acquired
by a smaller competitor, Dynergy. On November 28, Enron’s public debt
was downgraded to junk bond status, and Dynergy withdrew from the acquisition.
Finally, with its stock price at only $0.26 on December 2, 2001, Enron led for
THE CHRONOLOGY OF THE FALL:
20 Feb, 2001
A Fortune story calls Enron a highly impenetrable Co. that is piling on debt while keeping the
Wall Street in dark.
14 Aug, 2001
Jeff Skilling resigned as chief executive, citing personal reasons. Kenneth Lay became chief
executive once again.
12 Oct, 2001
Arthur Anderson legal counsel instructs workers who audit Enron’s books to destroy all but the
most basic documents.
16 Oct, 2001
Enron reports a third quarter loss of $618 million.
24 Oct 2001
CFO Andrew Fastow who ran some of the controversial SPE’s is replaced.
8 Nov 2001
The company took the highly unusual move of restating its profits for the past four years. It
admitted accounting errors, inflating income by $586 million since 1997. It effectively admitted
that it had inflated its profits by concealing debts in the complicated partnership arrangements.
Enron filed for Chapter 11 bankruptcy protection and on the same day hit Dynegy Corp. with a
$10 billion breach-of-contract lawsuit.
12 Dec 2001
Anderson CEO Jo Berardino testifies that his firm discovered possible illegal acts committed by
9 Jan 2002
U.S. Justice department launches criminal investigation.
Hence within three months Enron had gone from being a company claiming assets worth
almost £62bn to bankruptcy. Its share price collapsed from about $95 to below $1.
Role of Andersen:
Arthur Andersen – one of the world's five leading accounting firms - was the auditor to Enron.
When the scandal broke. Andersen’s chief auditor for Enron, David Duncan, ordered the
shredding of thousands of documents that might prove compromising. Andersen has dismissed
Mr Duncan and Andersen’s chief executive at the time of the Enron collapse, Jo Berardino,
resigned at the end of March 2002
Besides obstruction of justice, Andersen also faces charges that it improperly approved of
Enron's off-balance-sheet partnerships, called "special purpose entities", which the company
used illicitly to hide losses from investors.
Creative Accounting: The Special Purpose Entities (SPE’s)
At the heart of Enron's demise was the creation of partnerships with shell companies, these
shell companies, run by Enron executives who profited richly from them, allowed Enron to keep
hundreds of millions of dollars in debt off its books. But once stock analysts and financial
journalists heard about these arrangements, investors began to lose confidence in the
company's finances. The results: a run on the stock, lowered credit ratings and insolvency.
According to claims and counter-claims filed in Delaware court hearings; many of the most
prominent names in world finance - including Citigroup, JP Morgan Chase, CIBC, Deutsche Bank
and Dresdner Bank - were still involved in the partnership, directly or indirectly, when Enron
filed for bankruptcy.
Originally, it appears that initially Enron was using SPE's appropriately by placing non energy
related business into separate legal entities. What they did wrong was that they apparently
tried to manufacture earnings by manipulating the capital structure of the SPEs; hide their
losses; did not have independent outside partners that prevented full disclosure and did not
disclose the risks in their financial statements.
There should be no interlocking management: The managers of the off balance sheet entity
cannot be the same as the parent company in order to avoid conflicts of interest. The
ownership percentage of the off balance sheet entity should be higher than 3% and the outside
investors should not be controlled or affiliated with the parent: This was clearly not the case at
Enron. Enron, in order to circumvent the outside ownership rules funneled money through a
series of partnerships that appeared to be independent businesses, but which were controlled
by Enron management. The scope and importance of the off-balance sheet vehicles were not
widely known among investors in Enron stock, but they were no secret to many Wall Street
firms. By the end of 1999, according to company estimates, it had moved $27bn of its total
$60bn in assets off balance sheet.
Satyam is the fourth largest IT service provider in India and is enlisted in New York Stock
Exchange. The company also boasts a clientlist of who-is-who of the industry and has more than
50,000 people on its pay roll. Satyam scandal has cast a shadow over the outsourcing industry
of India, and has shook the confidence of the investors in the Indian market. The financial
irregularities of such a high level were unheard of in the IT sector until yet but the recent
developments in Satyam has raised questions about the management of companies of such a
Ramalinga Raju and his brother Rama Raju, accused of committing a Rs40 billion fraud that
threaten to shake the very foundation of Satyam Computers. The Government has further
offered financial support to bail out the beleaguered Satyam. The 50,000 odd employees of
Satyam find themselves at sea, with some IT majors deciding against hiring displaced Satyam
staff. There are fears over the adverse fallouts of the Satyam fraud on the international
reputation of the exports-driven Indian IT industry.
Byrraju Ramalinga Raju founded Satyam Computers in 1987 and was its Chairman until January
7, 2009 when he resigned from the Satyam board after admitting to cheating six million
shareholders, some of whom have lost their entire life savings.. After being held
in Hyderabad's Chanchalguda jail on charges including cheating, embezzlement and insider
trading, Raju was granted bail on 18 August 2010.
WHAT BASICALLY HAPPENED?
The Satyam Computer Services scandal was publicly announced on 7 January 2009, when
Chairman Ramalinga Raju confessed that Satyam's accounts had been falsified.
Chairman Ramalinga Raju resigned after notifying board members and the Securities and
Exchange Board of India (SEBI) that Satyam's accounts had been falsified
Raju confessed that Satyam's balance sheet of 30 September 2008 contained:
Inflated figures for cash and bank balances of 5,040 crore (US$ 1.09 billion) as against
5,361 crore (US$ 1.16 billion) crore reflected in the books.
An accrued interest of 376 crore (US$ 81.59 million) which was non-existent.
An understated liability of 1,230 crore (US$ 266.91 million) on account of funds was
arranged by himself.
An overstated debtors' position of 490 crore (US$ 106.33 million) (as against 2,651
crore (US$ 575.27 million) in the books).
Raju claimed in the same letter that neither he nor the managing director had benefited
financially from the inflated revenues. He claimed that none of the board members had any
knowledge of the situation in which the company was placed.
Following is a copy of his letter
To the Board of Directors
Satyam Computers Services Ltd.
From B. Ramalinga Raju
Chairman, Satyam Computer Servcies Ltd
Dear Board Members,
It is with deep regret, and tremendous burden that I am carrying on my conscience, that I
would like to bring the following facts to your notice:
1. The balance sheet carries as of September 30, 2008
a) Inflated (non-existent) cash and bank balance of Rs 5,040 crore (as against Rs 5361 crore
refglected in the books)
b) An accured interest of Rs 376 crore which is non-existent
c) An understated liability of Rs 1,230 crore on account of funds arranged by me
d) An over stated debtor position of Rs 490 crore (as against Rs 2651 reflected in the books)
2. For the September quarter (Q2) we reported a revenue of Rs 2,700 crore and an operating
margin of Rs 649 crore (24 per cent of revenues) as against the actual revenues of Rs 2,112
crore and an actual operating margin of Rs 61 crore (3 per cent of revenue). This has resulted in
artificial cash and bank balances going up by Rs 588 crore in Q2 alone.
3. The gap in the balance sheet has arisen purely on account of inflated profits over a period of
last several years (limited only to Satyam standalone, books of subsidiaries reflecting true
performance). What started as a marginal gap between actual operating profit and the one
reflected in the books of accounts continued to grow over the years. It has attained
unmanageable proportions as the size of the company operations grew significantly (annualized
revenue run rate of Rs 11,276 crore in the September quarter, 2008 and official reserves of Rs
8.392 crore). The differential in the real profits and the one reflected in the books was further
accentuated by the fact that the company had to carry additional resources and assets to
justify higher level of operations – thereby significantly increasing the costs.
Every attempt made to eliminate the gap failed. As the promoters held a small percentage of
equity, the concern was the poor performance would result in a takeover, thereby exposing the
gap. The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones.
It was like riding a tiger, not knowing how to get off without being eaten.
Raju had appointed a task force to address the Maytas situation in the last few days before
revealing the news of the accounting fraud. After the scandal broke, the then-board members
elected Ram Mynampati to be Satyam's interim CEO. Mynampati's statement on Satyam's
"We are obviously shocked by the contents of the letter. The senior leaders of Satyam stand
united in their commitment to customers, associates, suppliers and all shareholders. We have
gathered together at Hyderabad to strategize the way forward in light of this startling
On 10 January 2009, the Company Law Board decided to bar the current board of Satyam from
functioning and appoint 10 nominal directors. "The current board has failed to do what they are
supposed to do. The credibility of the IT industry should not be allowed to suffer." said
Corporate Affairs Minister Prem Chand Gupta. Chartered accountants regulator ICAI issued
show-cause notice to Satyam's auditor PricewaterhouseCoopers (PwC) on the accounts fudging.
"We have asked PwC to reply within 21 days," ICAI President Ved Jain said.
On the same day, the Crime Investigation Department (CID) team picked up Vadlamani Srinivas,
Satyam's then-CFO, for questioning. He was arrested later and kept in judicial custody.
On 11 January 2009, the government nominated noted banker Deepak Parekh, former
NASSCOM chief Kiran Karnik and former SEBI member C Achuthan to Satyam's board.
Analysts in India have termed the Satyam scandal India's own Enron scandal. Some social
commentators see it more as a part of a broader problem relating to India's caste-based,
family-owned corporate environment
Immediately following the news, Merrill Lynch now a part of Bank of America and State Farm
Insurance terminated its engagement with the company. Also, Credit Suisse suspended its
coverage of Satyam.. It was also reported that Satyam's auditing firm
PricewaterhouseCoopers will be scrutinized for complicity in this scandal. SEBI, the stock
market regulator, also said that, if found guilty, its license to work in India may be revoked.
Satyam was the 2008 winner of the coveted Golden Peacock Award for Corporate Governance
under Risk Management and Compliance Issues, which was stripped from them in the
aftermath of the scandal. The New York Stock Exchange has halted trading in Satyam stock as of
7 January 2009. India's National Stock Exchange has announced that it will remove Satyam from
its S&P CNX Nifty 50-share index on 12 January. The founder of Satyam was arrested two days
after he admitted to falsifying the firm's accounts. Ramalinga Raju is charged with several
offences, including criminal conspiracy, breach of trust, and forgery.
Satyam's shares fell to 11.50 rupees on 10 January 2009, their lowest level since March 1998,
compared to a high of 544 rupees in 2008. In New York Stock Exchange Satyam shares peaked
in 2008 at US$ 29.10; by March 2009 they were trading around US $1.80.
The Indian Government has stated that it may provide temporary direct or indirect liquidity
support to the company. However, whether employment will continue at pre-crisis levels,
particularly for new recruits, is questionable.
On 14 January 2009, Price Waterhouse, the Indian division of PricewaterhouseCoopers,
announced that its reliance on potentially false information provided by the management of
Satyam may have rendered its audit reports "inaccurate and unreliable”.
On 22 January 2009, CID told in court that the actual number of employees is only 40,000 and
not 53,000 as reported earlier and that Mr. Raju had been allegedly withdrawing INR 20 crore
rupees every month for paying these 13,000 non-existent employees.
Prof. Sapovadia, in his study, shows that in spite of there being a strong corporate governance
framework and strong legislation in India, top management sometimes violates governance
norms either to favour family members or because of jealousy among siblings. He finds that
there is a lack of regulatory supervision and inefficiency in prosecuting violators. He investigates
in detail the recent governance failure at India's 4th largest IT firm, Satyam Computers Services
Limited, and considers possible reasons underlying such large failures of oversight.
NEW CEO AND SPECIAL ADVISORS
On 5 February 2009, the six-member board appointed by the Government of India named A. S.
Murthy as the new CEO of the firm with immediate effect. Murthy, an electrical engineer, has
been with Satyam since January 1994 and was heading the Global Delivery Section before being
appointed as CEO of the company. The two-day-long board meeting also appointed Homi
Khusrokhan (formerly with Tata Chemicals) and Partho Datta, a Chartered Accountant as special
Mahindra Satyam (formerly known as Satyam Computer Services Ltd) was founded in 1987 by B
Ramalinga Raju. The company offers consulting and information technology (IT) services
spanning various sectors, and is listed on the New York Stock Exchange, the National Stock
Exchange (India) and Bombay Stock Exchange (India). In June 2009, the company unveiled its
new brand identity “Mahindra Satyam” subsequent to its takeover by the Mahindra Group’s IT
arm, Tech Mahindra.
In 2008, Satyam attempted to acquire Maytas Infrastructure and Maytas Properties founded by
family relations of company founder Ramalinga Raju for $1.6 billion, despite concerns raised by
independent board directors. Both companies are owned by Raju's sons. This eventually led to
a review of the deal by the government, a veiled criticism by the vice president of India and
Satyam's clients re-evaluating their relationship with the company. Satyam's investors lost
about INR 3,400 crore in the related panic selling.
ated panic selling.