In 1957, Mundhra got the government-owned Life Insurance Corporation (LIC) to invest Rs. 1.24 crores (about USD 3.2 million at the time) in the shares of six troubled companies belonging to Mundhra: Richardson Cruddas, Jessops, Smith Stanistreet, Osler Lamps, Agnelo Brothers and British India Corporation. The investment was done under governmental pressure and bypassed the LIC’s investment committee, which was informed of this decision only after the deal had gone through. In the event, LIC lost most of the money.
The irregularity was highlighted in 1958 by Feroze Gandhi of the Indian National Congress party, who represented the Rae Bareli seat in the Parliament of India. Jawaharlal Nehru was Prime Minister at the time, and Feroze was married to his daughter Indira Gandhi. Nehru, as the leader of the ruling Congress party, wished to have the LIC matter handled quietly since it might show the government in a poor light.
However, Feroze Gandhi was the primary force behind an anti-corruption movement that in 1956 resulted in imprisonment of one of India's wealthiest men, Ram Kishan Dalmia, for defrauding his life insurance company. Subsequently, the parliament had passed the Life Insurance of India Act on June 19, 1956, under which 245 firms were nationalized and consolidated under the Life Insurance Corporation. Hence, he looked upon the LIC as a "child of Parliament". He would have no softpedalling on the matter, and took the case directly to parliament:
However, the matter was dramatized further in the public mind by the tense relations between Feroze and his father-in-law.
Feroze Gandhi had married Indira over initial objections of Jawaharlal, but Indira had gotten him to agree to the marriage, and relations between the men were cordial. Indira often helped her father in his duties, acting as official hostess, and helping run the huge residence. In 1949, Indira and their two sons Rajiv Gandhi and Sanjay Gandhi moved to Delhi to live with Jawaharlal, while Feroze continued alone in Lucknow. In 1952, after Feroze Gandhi was elected to Parliament (his campaign was managed by Indira), he also moved to Delhi, where he was assigned an MP quarters, but "Indira continued to stay with her father, thus putting the final seal on the separation.".
This rift was well known and it lent drama to the already sensational matter when Feroze Gandhi raised the Mundhra question on the floor of the parliament. Standing from the treasury benches, he asked the government if the newly formed Life Insurance corporation had used premiums from 5.5 million life-insurance policyholders to buy up shares at above-market prices in companies controlled by the notorious stock speculator named Haridas Mundhra?
Thus the prime minister was confronted by his own son-in-law. The fiery Finance minister, himself a noted industrialist, initially snapped "That is not the fact,", but had to admit later that this was the case.
Given the public spotlight, the government was forced to appoint a committee to examine the matter. The retired Bombay High court Justice M. C. Chagla was appointed as a one-man committee. Chagla held that a transparent and public enquiry was a "very important safeguard for ensuring that the decision will be fair and impartial. The public is entitled to know on what evidence the decision is based.". Consequently, large crowds would attend the hearings which were concluded in just 24 days. Several leading stockbrokers who were on the LIC Investment Committee testified that the investment could not have been made for the purpose of propping up the market, as was claimed by the Finance Ministry, and that had the LIC consulted the Investment Committee, they would have pointed out Mundhra's forged shares episode from 1956.
Justice Chagla determined that the Finance Secretary, H. M. Patel, along with two LIC officials, L S Vaidyanathan, may have colluded on the payment, and should be tried. The Finance Minister T. T. Krishnamachari, in his testimony tried to distance himself from the LIC decision, implying that it may have been taken by the Finance Secretary, but Justice Chagla held that the Minister is constitutionally responsible for the action taken by his secretary and he disown his actions. Eventually, Krishanamachari had to resign. The Nehru government suffered considerable loss of prestige in the incident.
Haridas Mundhra was arrested from his luxury suite at the Claridge's Hotel in Delhi, and sent to prison.
It turned out that Mundhra’s manipulations were not restricted to LIC. The income tax department had curiously withdrawn certain notices pending against him having entered into "some understanding" about the payment of arrears.
In recent times, Mundhra is often noted as the forerunner of other financial scamsters of modern India, including Harshad Mehta and Abdul Karim Telgi, who also operated with considerable political connivance. However, unlike in the Mundhra case, the government response in appointing an honest and competent judge, and also the judicial investigation (24 days of public hearings) has been far from transparent. This lack of transparency has also been commented upon in the public investigation of the Bofors Scandal, one of India's largest scandals, which involved Feroze Gandhi's son Rajiv Gandhi, the Prime Minister at the time.