Securities Scam Genesis, Mechanics and Impact

The term "securities scam" refers to a diversion of funds to the tune of over Rs. 3500 crores from the banking system to various stockbrokers in a series of transactions (primarily in Government securities) during the period April 1991 to May 1992. The scam has for several months become a permanent feature of the front pages of the newspapers. Despite the massive media coverage of the scam, most readers found it hard to understand it particularly when they were confronted with arcane terms and acronyms like ready forward, double ready forward, SGL, PDO, BR, PMS etc. Nevertheless an understanding of the scam is a prerequisite for any meaningful analysis of policy alternatives to improve the functioning of the financial system. This paper presents a plausible reconstruction of how the scam originated, how it was perpetrated, and what would be its aftermath. The paper is expository in nature and the authors make no claims to omniscience. The paper goes on to discuss the response of the government to the scam in terms of 1) discovering and punishing the guilty, 2) recovering the money, and 3) reforming the system. While agreeing with the importance of discovering and punishing the guilty, the paper argues that the attempt of the government to recover the money by such measures as the tainted shares law which cause severe and unjustified hardship to genuine and innocent investors is misguided. Turning to the arena of reforms of the financial system, the paper argues that the origins of the scam lie in overregulation of our markets. It recommends that normal transactions must be allowed to be done openly and transparently, and the role of brokers as market makers must be recognized. The second lesson from the scam is that artificial insulation of closely related markets from each other is counterproductive in the long run. Artificial barriers between the money market and the capital market, between the market for corporate securities and the market for government securities and between the formal money market and the informal one must be eliminated.