ALLIANCE SCHOOL OF LAW, ALLIANCE UNIVERSITY
COMPANY LAW
[CLAW 217 ]
SUBMITTED TO :
Prof. Dr. Rashmi K S
SUBMITTED BY :
Snigdha Tadakanti (019)
Manav Mukherjee (055)
DATE OF SUBMISSION
20TH November, 2022
TOPIC: Ketan Parekh Scam, a critical analysis – the failure of corporate
governance.
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INTRODUCTION
India has experienced major financial scams almost every year since the 1990s. There is a
well-documented history of these scams in the financial markets. The famous Harshad Mehta
scam in 1992 which was the beginning and one of the biggest scams ranging from MS Shoes
(1995) and Bhansali (1996) securities scam, Ketan Parikh Scam (2001), DSQ Software Scam
(2001), IPO Demat Scam (2006), Vanishing Companies (2007), Satyam Computer Scam
(2008), HomeTrade (2010), Sahara India Pariwar Investor Fraud (2010), Home Trade (2010),
ULIP Misselling (2011), Saradha Group Financial Scandal ( 2013), NSEL scam (2013),
PACL Ponzi scam scheme (2014). These scams have led to regulatory reforms, the creation
of new institutions and the strengthening of the institutional framework. The newspaper
attempts to critically analyse the 2001 Ketan Parekh scam. SEBI found Ketan Parekh, a
former stockbroker, guilty of stock manipulation and insider trading. He has been cited as one
of the main culprits behind the 176-point decline in Sensex that led to the fiscal crash of
2001. He used to artificially manipulate the prices of carefully selected stocks, known as K-
10 stocks, and obtain loans from banks such as Global Trust Bank and Madhavpura
Mercantile Cooperative Bank. The Serious Fraud Investigation Office (SFIO) estimates
Ketan Parekh's fraud at more than Rs 40,000 crore.
Ketan Parekh is a Chartered Accountant by profession. The institutional brokerage business
under the name of Narbheram Harakchand Securities (NH Securities) was a family business
of Mr. Parekh which he inherited from his father. He was a trainee in Harshad Mehta’s
company, GrowMore. He was a suspect in numerous frauds that Growmore was involved in,
although he was never found guilty. With the emergence of the dot com boom in the late
1990s, he began investing in low-liquidity IT and telecom firms, which were known as the
‘K-10’ stocks. K-10 stocks were Pentamedia Graphics, HFCL, GTL, Silverline Technologies,
Ranbaxy, Zee Telefilms, Global Trust Bank, DSQ Software, Aftek Infosys and SSI. He
owned roughly 16 percent of Global’s floating shares, 25 percent of Aftek Infosys, and 15
percent of Zee and HFCL, respectively. As a result of the significant growth in the value of
K-10 stocks, brokers and fund managers began to invest extensively in K-10 stocks. Ketan
Parekh and Vinay Maloo along with Kerry Packer launched KVP Ventures primarily
focusing on information technology software, internet, e-commerce, media and
entertainment, and telecommunications with an initial capital of $250 million on 27 March
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2000. For fraudulently rigging the pricing of K-10 shares, he was barred from trading in the
Indian stock market for 14 years. These security scams and financial scandals involved the
manipulation of huge amounts of money. These manipulators, including Ketan Parekh, had a
very comprehensive knowledge of the system’s working and opportunistically
manipulated it.
RESEARCH OBJECTIVES
To study and analyse the Ketan Parekh’s scam.
To understand the concept of corporate governance and the reasons for its failure in
this scam.
To examine the role of SEBI in protecting market integrity.
To study and understand the various legal aspects which are surrounded by the scam.
RESEARCH QUESTIONS
Whether there are any legal provisions and implications under SEBI and Companies
Act ,2013 for financial frauds.
Whether there was any failure of corporate governance.
Whether a good corporate governance would lead to proper working of the company
and protect from the financial frauds.
RESEARCH PROBLEM
Sometimes, due to the failure of corporate governance, the possibility of scam occurs which
lead to the closure and downfall of companies.
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LITERATURE REVIEW
The methodology of research referred to in this paper is the doctrinal method of research.
Doctrinal method of research: The most prevalent methodology used by persons to do
research and that is doctrinal or library-based research. Many other resources like Articles
from the internet and books were also referred in this paper. As this is generally known, this
is completely theoretical research that consists of either simple research targeted at locating
a single problem and researching on that particular problem. In a nutshell, it's library-based
as well as internet based research and is aimed at determining the "one correct answer" to an
issue or topic.
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IN-DEPTH STUDY OF KETAN PAREKH’S SCAM
In 1999-2000, as the tech bubble engulfed the rest of the world, the Indian stock market also
came alive. Whatever it may be, like the investment firms, mostly they are controlled by
listed company founders, foreign companies or credit unions , they were all willing to hand
over the money to Parekh ,which he used to manipulate the prices of the actions in their
interest. Evidently, In a short period of time scripts like Visualsoft rose from Rs 625 to
Rs 8448 per share and Sonata Software from Rs 90 to Rs 2150.The vicious cycle of fraud
didn’t end with price gauging. This had led to inflated shares which had ended up by being
dumped on someone.
Parekh’s initial move was to raise the substantial stakes from promoters at deep discounts and
he shifted his focus mainly to institutional investors. He was, of course , very optimistic about
the stock market. It required three elements to drive the market: stocks, the stock market and
finance. The BSE became more cautious after the stock scam in 1992.They increased the
security and also came up with fraud detection. Therefore, Ketan Parekh was listed on
Kolkata Stock exchange , which lacked rigorous and important restrictions. Parekh’s stock
selection was based on four major important key factors:
The business must be small;
The company must have a low volume;
The company’s future prospects must be high; and
The company’s market capital must be low.
The stock portfolio was mainly focused on the technology, communication and entertainment
industries after the advent of the dot-com boom which is Popularly known as the ICE
sector. Here, they are known as "K-10" stocks. The funds were raised by promoters such as
Global Tele- systems, Himachal Futuristic Communications Ltd and Zee Telefilms with
their own money. Some funds have also been raised by institutional investors through mutual
funds, hedge funds, insurance companies, P/E funds or banks such as global trust bank and
Madhavpura Mercantile Cooperative Bank in the form of loans and pay orders without
adequate securities. He bought some shares in MMCB, in order to influence the bank’s credit
decision in his favour. At that time, the RBI allowed traders to borrow around Rs.15 crores.
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In March 2001, MMCB issued Pay Orders of Rs. 137 Crores for Ketan’s Companies: 65
crores to Classical Share and Stockbrokers, 20 crores to Panther Investrade, and 52 crores to
Panther Fincap which were discounted by Bank of India and all these companies had their
accounts in Bank of India as well. However, the Reserve Bank of India intervened in 2001
and returned the bounced pay orders to the Bank of India. MMCB was unable to clear the
payments because it lacked adequate money. RBI labelled MMCB a defaulter, and BOI
suffered a loss of Rs. 137 crores. Ketan Parekh paid back only Rs. 7 crores, which led to the
filing of a 130 crore Rupees fraud case against him. The entire scheme was exposed after
Ketan was detained by the Central Bureau of Investigation.
In 2001, simply once the Indian Union Budget had been presented, the BSE Sensex crashed
at 176 points, prompting the then NDA government to line up to inquiry into the market
reaction. Afterwards, the RBI refused to clear pay orders (POs) that had been given by
Parekh as collateral for loans to BOI (Bank of India), as they found them to be suspicious.
The run commenced an investigation against Parekh. Around the same time, a bear corporate
trust of brokers in Mumbai opposed to Parekh and tried to dump their shares of K-10 stocks.
Panicking, Parekh sold off his entire ownership of the so-called K-10 stocks which he
had with success jacked up over the past 2 years, particularly those of two entities - GTB
bank and MMCB bank. He carried out this large scale dump in the evening, after regular
trading hours, from 5 PM to midnight at the Calcutta Stock Exchange. This resulted in a stock
market crash the next day, resulting in large scale losses for large institutional investors,
including insurance companies and mutual funds.
He adopted two methods for his operation, pump and dump scheme, and circular trading. The
initial stage of the pump and dump strategy was to inflate stock value artificially. He invested
in K-10 stocks by acquiring about 20-30% of the company’s stock which was less well-
known in the stock market and inflated the price of the shares, which eventually became
overvalued leading to enticing the institutional brokers and investors to invest in the shares.
Then he dumped the shares, causing the stock prices to fall drastically.
In circular trading also known as the “badla system”, he traded the stocks between his entity
and other friendly entities. Prices of the stock valuation were raised by luring investors and
traders for high liquidity through his operational team’s large volume of trading of similar
sell orders for the same number of stocks and at the same price and at the same time which
showed the high demand and created large volumes of the stock in the market.
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LEGAL PROVISIONS UNDER COMPANY LAW ACT ,2013
Under Section 447, ‘fraud’ is defined as “any act, omission, concealment of any fact, or
abuse of position committed by a person with the intent to mislead, obtain an unfair
advantage, or harm the interests of the corporate , its shareholders, its creditors, or the other
person, whether or not there's any wrongful gain or loss.”
Any person found guilty of fraud faces a fine of at least ten lakh rupees or 1% of the
company’s annual revenue, whichever is lower, also as a term of imprisonment that must not
be less than six months but may not exceed ten years. they're also subject to a fine that must
not be less than the amount involved in the fraud but may not be less than three times the
amount involved in the fraud. If the fraud concerns a matter of public interest, the sentence
can't be less than three years.
Section 36 deals with the punishment for fraudulently inducing someone to take a position
money by making false statements, promises, or forecasts that are false, deceptive, or
misleading, or knowingly conceals any material facts, so as to persuade someone to enter into
or offer to enter into any agreement with a view to purchasing, selling, subscribing for, or
underwriting securities or any agreement that's purportedly intended to secure a profit for any
party or fraudulently obtaining credit facilities from any bank or financial institution will be
punished under Section 447.
Section 38 deals with the punishment for personation for acquisition, etc., of securities. a
person who submits an application to a company in a false identity to purchase or subscribe
to its securities, or who submits multiple applications to the identical company under
different variations of name for acquiring or subscribing for its securities, or induces the
corporate , directly or indirectly, to allot securities to him or the other person in a fictitious
name will be punished under Section 447.
Section 229 deals with penalties for providing false information, document mutilation, and
document destruction. When an individual tampers, conceals, mutilates, misrepresents, or
removes documents that pertain to the company’s or body corporate’s property, assets, or
business, or once they are involved in any of these actions, or once they make false entries in
documents pertaining to the company or body corporate, or once they provide an explanation
that is false or that they know to be false, shall be punishable under section 447.
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Section 251 deals with the fraudulent applications for removal of name. If an application by a
corporation under Section 248(2) has been made to evade the liabilities of the company, or to
deceive the creditors or to defraud the other persons., The person on top of things of the
management of the company is jointly and severally liable to any person or persons who had
suffered loss or damage as a result of the company being notified as dissolved, and are
punishable for fraud within the manner prescribed by law in Section 447.
Section 448 deals with punishment for false statements, a person who makes a statement that
is false in any material particulars and knows it to be false or omits any material fact and
knows it to be material in any return, report, certificate, budget , prospectus, statement, or
other required document is subjected to punishment under Section 447.
ROLE OF SEBI IN THIS CASE:
The Securities and Exchange Board of India (SEBI) is the regulatory body for securities and
commodity market in India under the ownership of Ministry of Finance within the
Government of India. It was established on 12 April 1988 as an executive body and was
given statutory powers on 30 January 1992 through the SEBI Act, 1992.
In the case of Securities and Exchange Board of India v. Panther Fincap and Management
Services Limited and Ors (2018), Ketan Parekh was found guilty of the offense and he was
imprisoned for a term of 3 years with a fine of Rs.5,00,000 under Section 24(2) of the
Securities and Exchange Board of India Act, 1992. This Section deals with the punishment
imposed by the adjudicating officer on anyone who fails to pay or comply with any of the
directions or orders, which may include imprisonment for a term of one month that may
extend to ten years or a fine that may extend to twenty-five crore rupees or both and under
Section 235(2) in the Code Of Criminal Procedure, 1973 states that if the defendant is found
guilty, the judge follows the guidelines under Section 360, hear the defendant on the issue of
sentencing before passing judgment on him in accordance with the law. He was also directed
to compensate an amount of Rs.3,25,000 to the Securities and Exchange Board of India.
Chapter VI-A deals with the penalties and adjudication under the Securities Exchange Board
of India Act, 1992. Section 12A prohibits the manipulation and use of fraudulent methods,
insider trading, and the direct or indirect acquisition of securities or control by any individual.
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Section 15A deals with penalties for failure to furnish information, return, etc. Section 15B
deals with the penalty for failure by any person to enter into an agreement with clients.
Section 15C deals with penalties for failure to redress investors‘ grievances. Section 15D
deals with a penalty for certain defaults in the case of mutual funds. Section 15E deals with
penalties for failure to observe rules and regulations by an asset management company.
Section 15H deals with penalties for non-disclosure of acquisition of shares and takeovers.
In the case of stock brokers, the penalty for default is dealt with under Section 15F. If an
individual fails to issue contract notes stipulated by the stock exchange of which he is a
member, he is subject to a penalty of up to five times the amount for which the contract note
was required. If any individual fails to deliver any security or fails to pay the sum due to the
investor in the way prescribed in the rules, he shall be subject to a penalty of one lakh rupees
for each day that such failure persists, or one crore rupees, whichever is less. If an individual
charges more than the amount provided in the regulations for brokerage, he will be penalised
1 lakh rupees or five times the amount charged more than the specified brokerage, whichever
is higher.
Insider trading is punishable under Section 15G. If any individual deals in securities of a
body corporate listed on any stock exchange on his behalf or behalf of any other person based
on any unpublished price sensitive information, or advises, or acquires for any other person to
deal in securities of any or causes any person to trade in any securities of anybody corporate
based on undisclosed price sensitive information, will be subject to a penalty of twenty-five
crore rupees or three times the amount of profits gained through insider trading, whichever is
higher.
Section 15HA establishes a penalty for fraudulent and unfair trade practices that may not be
less than five lakh rupees and extend to twenty-five crore rupees, or three times the amount of
profits derived from such practices, whichever is higher.
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CORPORATE GOVERNANCE, its role in controlling scams:
Governance refers specifically to the set of rules, regulations, policies and controls
established to guide corporate behaviour. A board of directors are mandatorily needed in
governance of the company. Proxy advisors and shareholders are important stakeholders who
can influence corporate governance. Communicating a company’s governance is a very
important key component for the community and for good investor relations. For example,
Apple Inc.’s investor relations website describes the company’s governance including the
executive team and BODs. It provides information on corporate governance , including
charters of committees and governance documents such as MOA ,stock ownership policies
and AOA. Most companies aspire to be exceptional in corporate governance. For many
shareholders , it is not enough that a company is profitable. It is also important to demonstrate
good corporate citizenship though environmental awareness, ethical behaviour and strong
corporate governance practices. Having a good corporate governance is very advantageous
for the entire company itself;
It creates transparent rules and controls, provides guidance to leadership, and
aligns the interests of shareholders, directors, management, and employees.
It helps build trust with investors, the community, and public officials.
Corporate governance can provide investors and stakeholders with a clear
idea of a company's direction and business integrity.
It promotes long-term financial viability, opportunity, and returns.
It can facilitate the raising of capital.
Good corporate governance can translate to rising share prices.
It can lessen the potential for financial loss, waste, risks, and corruption.
It is a game plan for resilience and long-term success.
CONCLUSION
Ketan Parekh fraud in the late 1990s brought about the collapse of several co-operative banks
and the largest mutual fund in India (Unit Trust of India US-64), which was located right in
the middle of the Indian financial system, the Satyam fraud clearly brings out the lacunae in
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the systems, practices and methods of auditing and accounting in India and situates itself
right at the heart of India’s booming IT industry.
The Satyam fraud is stunningly alarming not only because it is the biggest accounting and
auditing fraud in India till date but also because it directly threatens to engulf the IT sector in
India at this time of economic downturn and undermine India’s global image as one of the
most promising economic stories in the new millennium. A chilling similarity between
Satyam and Parekh lies not just in the scale of the frauds but also the incidence of criminal
conduct by the top management of the various companies involved and the conflicting
interests between the various groups of accountants, bankers, auditors and top management.
An inescapable factor is the clearly questionable auditing standards at large and the
professional ethics generally of the auditors who have supposedly audited the company’s
books for at least the last four to five years.
In the aftermath of the fraud, SEBI incorporated Clause 49 to the Listing Agreement to make
sure that businesses behave in the best interests of the market by adhering to excellent
corporate governance principles. To stop these frauds, RBI has also sought to make the laws
and regulations better. To assist banks in finding cases of borrower fraud at an early stage, the
RBI has established a Central Fraud Registry Portal, a searchable database and all Indian
banks have access to the platform. Though post the scam, resolutions where brough and the
loopholes where filled but in all just the occurrence a scam of this scale for this long
portrayed the utter
failure of the corporate governance.
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