How the 1958 Mundhra scam exposed the nexus between LIC, the bureaucracy and rogue businessmen

After the floundering of the stock markets, soon after his budget speech, TT Krishnamachari adopted a two-pronged approach to restore confidence and maintain the balance of the financial system.

The first was to support the stock markets by purchasing sound equities using LIC funds in the private sector. LIC came forward in the middle of May 1957 and purchased substantial shares of Tata Iron and Steel Co (TISCO), Indian Iron and Steel Co (IISCO) and Associated Cement Company (ACC). Incidentally, like the investment in the Mundhra’s companies’ scrips, these investments too were made at the behest of the government, without taking the prior approval of LIC’s investment committee (see below). However, these were profit-making blue-chip companies, leaders in their field, and sound investments. Using this as a precedent to invest in Mundhra scrips was incorrect.

More fundamentally, the task of stabilising markets was not incumbent upon LIC or a part of its charter. “Nowhere is it laid down that LIC should buy or sell shares to regulate prices or yields. Nor has LIC the resources of technical competence to undertake such a task… Equity prices by their very nature are subjected to wide variations and no corporation is expected to take up an impossible adventure.”

Around the same time, RBI began to fear that Mundhra’s financial difficulties would prevent banks from realising their debts without unloading his shares on the market. This might have triggered a crash in their prices, eroding the realizable value of the banks’ securities. RBI examined the possibility of Mundhra’s creditors forming a consortium to coordinate the recovery of their advances to him. The banks, however, refused to participate as their legal counsel warned that they could be liable to civil suits by Mundhra, should he suffer any loss or adversity because of their action.

By June 1957, Mundhra was in serious trouble. He had approached GD Birla for help in liquidating a part of his holdings, but Birla felt that with the tight conditions in the money market, no one would be prepared to buy the shares. Birla suggested that Mundhra should meet TTK and ask for his advice. By this time, the Punjab National Bank, which had been accommodating Mundhra, was pressing him to repay, and Birla felt that Mundhra risked losing control of Turner Morrison.

The LIC Act, 1956 had provided for the setting up of an investment committee, as an advisory body, for prudent investment of the corporation’s funds. It began functioning in September 1956, comprising seven members: four official and three non-official. The official members included the chairman, the managing director of the LIC and two government representatives, one representing the Ministry of Commerce and Industry and the other, the company law department. The three non-officials included the presidents of the BSE and the Calcutta Stock Exchange (CSE), and HT Parekh, then the deputy general manager of Industrial Credit & Investment Corporation of India, (now ICICI Bank).

The committee met fortnightly and decided on investments based on (a) a proper examination of prospects of each industry and of each company, (b) comparative rates of return from different investments, (c) the extent of LIC’s present investments in each company, to ensure that there was no concentration of risk or anything that could indicate partiality/preference, (d) the standard of management in the companies where public funds were being invested, and (e) the contribution which LIC might make to promote industrial development by doing that investment.

LIC’s investments in the steel and cement companies mentioned above were ratified post facto at the next meeting of the investment committee. The committee didn’t express an opinion in the way the purchases had bypassed the committee and thus accorded their tacit approval.

TTK’s second measure was to allay the apprehensions of industrialists and other businessmen. Towards this, he held several meetings in Calcutta and Bombay along with his advisory team on economic affairs, comprising HVR Iyengar, PC Bhattacharya; and HM Patel.

A meeting was held on June 18, 1957, with the businessmen in Calcutta. While happy that LIC had stepped in to stabilise the market, some of them voiced their concern on the unstable stock markets on account of Mundhra’s shares. TTK and his team were aware that not just banks, but brokers and individuals holding Mundhra shares by way of pledges were in difficulties. Mundhra could neither redeem the shares held, nor pay the margins. They appeared to have little option but to sell the shares and cut their losses.

After the meeting of June 18, SC Chaturvedi, president, CSE reportedly told Iyengar and Patel that the biggest single cause of the trouble in the market was that a large quantity of Mundhra shares was likely to be thrown on the market at distress prices. Though moot, hopefully, Chaturvedi’s concerns were made and received as those stemming from a worried President of the CSE rather than as a member of LIC’s investment committee. However, there is evidence that Mundhra was a close friend of Chaturvedi, hence the story may have been fabricated and propounded by Mundhra himself to throw the scare of brokers’ selling and to prompt LIC to invest.

TTK and his team decided to reconvene on June 22 in Bombay, to discuss the issue further. On June 21 morning, Bhattacharya asked Patel if he could give Mundhra an audience (Mundhra had travelled from Calcutta to Bombay for the meeting as had Patel and TTK). At that meeting, Mundhra spoke about his difficulties in a general way and made certain proposals. Patel asked him to send his proposals in writing, which Mundhra did on June 22, sending copies of his letters to Iyengar and Bhattacharya as well. Mundhra’s proposal was that LIC should buy shares worth Rs 80 lakhs from him and pick up another Rs 30 to 40 lakhs from the market to stabilise it.

Additionally, he wanted a loan of Rs 1 crore from LIC. He also suggested that LIC should buy fresh issues of preference shares of BIC and Jessops to the extent of Rs 1.25 crores, and offered as a sweetener, fire insurance business worth Rs 15 lakhs. Attached to Mundhra’s letter was a list of his total liabilities amounting to about Rs 5.25 crores of which Rs 3.93 crores were owed to banks and the rest to brokers. His unencumbered assets amounted to Rs 1.55 crores. On the morning of June 22, at a meeting along with Iyengar and Bhattacharya, Patel showed Mundhra’s letter to TTK. They agreed that of the various proposals, the purchase of shares was the only feasible way. TTK approved Patel’s discussing the matter with the LIC.

The same afternoon, Patel met LIC Chairman GR Kamat, along with Bhattacharya to discuss the proposal. On June 23, which happened to be a Sunday, Patel, Kamat, and Bhattacharya met Mundhra. At this meeting, Mundhra was invited to come up with definite proposals. Patel, Bhattacharya and Kamat agreed to purchase shares mainly of BIC, Jessop, and Richardson Cruddas for about Rs 1 crore.

Thereafter Patel and Bhattacharya met TTK along with state finance ministers. TTK was satisfied at LIC’s willingness to purchase the shares but warned about the need for caution on account of news circulating about Mundhra’s spurious scrips.

The following day, Mundhra’s proposals were tabled in a meeting. In addition to the others at the Sunday meeting, LS Vaidyanathan, Managing Director LIC; RG Vaidya, General Manager Oriental Insurance, and Mundhra’s representative ML Sodhani were present. Proposals such as the formation of a holding company alone on immovable property or the purchase of shares in the open market, etc., were rejected. Then came the decision of the amount necessary for the investment. Mundhra gave details about his most pressing liabilities. It emerged that it would be necessary for him to have about one and a quarter crore rupees, if the pressure on the Calcutta market was to be effectively reduced. The total number of shares of each individual company to be purchased was discussed next. Mundhra’s request for the purchase of shares at prices higher than the current (depressed) rates was denied; he was also asked to provide a written assurance that he would replace any scrip if found to be spurious or unsatisfactory.

On June 25, 1957, LIC wrote to Mundhra, communicating its willingness to buy from him an agreed list of shares of six of his public companies at prices prevailing at the close of trading the previous day, Monday, June 24.

The deal finalised by LIC on June 25 was however, not the first investment by the corporation in shares of Mundhra’s companies. In March-April 1957, LIC had bought 50,000 shares of Jessop without the advice of the investment committee, directly from Mundhra at prices higher than the market. Shares of two other companies had been purchased, with only one of the two deals being concluded through brokers. These investments occurred apparently at the behest of HM Patel who was then the chairman of the Corporation. This was surprising since the then finance minister, Deshmukh had clearly proscribed involvement in Mundhra companies.

In September 1957, LIC entered four more purchase transactions through a firm of brokers, which included shares of Jessop and Richardson & Cruddas. But the deal of June 25, 1957, was the biggest by far of any single investment the LIC had undertaken until then. It appears that LIC’s total investment in Mundhra firms for all purchases was about Rs 156 lakhs.

While both the Chagla Commission and the Bose Board (discussed later) found that the statements of those involved were conflicting and that the entire truth hadn’t been revealed, from the speed and sequence of events it becomes clear that LIC (at the government’s initiation) was indeed bending over backwards for Mundhra.

Excerpted with permission from The Founding Fathers of Fraud: Independent India’s First Scandals that Rocked the Nation, Bhaswar Mukherjee, Srishti Publishers.