By David Yerushalmi, Esq.
© Copyright 2008. All rights reserved to the Law Offices of David Yerushalmi. No reproduction, publication, or distribution of all or
any part of this memorandum/article is authorized without the expressed written permission of the copyright holder.
I. Introduction:
The legal practitioner, motivated by the exorbitant fees awarded specialists who have
acquired expertise in a novel, complex, and highly profitable financial structure, often
loses sight of the fundamental threshold issues for such legal structures: whether the
transaction or business model complies with existing civil and criminal statutory and
regulatory frameworks, and whether the transaction exposes the client to unique and
elevated civil liability, criminal exposure, or regulatory intervention.1
Unfortunately, the history of the legal and accounting professions in guiding clients
through the hazards of novel and complex transactions has been poor. Perhaps nowhere is
this more evident than in the professional treatment of Sharia’ah-compliant finance
(“SCF”), the practice of investing in conformity with Islamic law. In just the past three
decades, financial institutions and finance-driven businesses have entered into countless
SCF transactions, facilitated by their attorneys, accountants, and financial advisors.2 Due
in part to the dependence of the SCF industry on a small group of Shari’ah authorities
associated with international terrorism, these transactions could potentially expose the
parties involved to significant civil and criminal liability in areas as diverse as securities
fraud, antitrust, and racketeering. The lesson professionals should have learned from the
lessons of the past -- but appear not to have, given what can only be described as the
blind exuberance driving SCF -- is that huge profits and explosive growth, massive public
relations and marketing efforts, and popular appeal in the financial industry do not
establish even a minimal baseline for legal compliance.
Whether a new financial product or an innovative structure for an existing business is
compliant with the civil, criminal, and regulatory frameworks imposed on a lightning fast
and fully reticulated finance-driven economy is no longer a question for a single
professional. Careful analysis and due diligence across several disciplines conducted in a
fully-informed, interactive environment is not a luxury of the prudent but a necessity for
all but the reckless.
This Article examines Shari’ah-compliant finance in light of existing U.S. law. It
highlights and examines areas of civil liability and criminal exposure unique to SCF
1 The post-Enron “Sarbanes-Oxley” world is the recent result of this failure. See, e.g., Harvey J.
Goldschmid, Comm’r, Sec. & Exch. Comm’n, Post-Enron America: An SEC Perspective,
Address at the Third Annual A.A. Sommer, Jr. Corporate Securities & Financial Law Lecture
(Dec. 2, 2002), available at http://www.sec.gov/news/speech/spch120202hjg.htm (last visited
Jan. 24, 2008).
2 Beyond the Enron-era, the financial world is in the midst of the “sub-prime mortgage
securitization” industry meltdown, see, e.g., Ben S. Bernanke, Chairman, Fed. Reserve, The
Recent Financial Turmoil and its Economic and Policy Consequences, Address at the Economic
Club of New York (Oct. 15, 2007), available at
http://www.federalreserve.gov/newsevents/speech/bernanke20071015a.htm (last visited Jan. 24,
2008), which is already being compared to the debacle of the Savings & Loan crisis, see, e.g.,
Amy Waldman, Move Over, Charles Keating - Causes Of The Savings And Loan Scandal,
WASHINGTON MONTHLY, May 1995, available at
http://findarticles.com/p/articles/mi_m1316/is_n5_v27/ai_16947718 (last visited Jan. 24, 2008).
2
investments and transactions3 in the U.S. as they have been developed and utilized by
various financial institutions and facilitated and promoted by legal, accounting, and
financial professionals.4 Part I provides an introduction to SCF and explains why it
should be subject to special scrutiny by lawyers, accountants, and other professional
advisers. Part II discusses the role of the professional in SCF transactions and suggests
an analytical framework for approaching the legal issues surrounding SCF in the U.S.
This framework divides the world of potential liability into two groups: liability arising
out of elements endogenous to SCF, involving issues about what Shari’ah actually is and
requires; and liability arising out of elements exogenous to SCF, such as the impact of
Western-adaptions of Shari’ah principles. Part III focuses in detail on the former, while
Part IV examines legal concerns related to the latter.
After examining the multitude of liability issues surrounding Shari’ah-compliant
financing, this Article concludes that SCF exposes the financial institutions and other
businesses which attempt to exploit this new industry to a host of disclosure, due
diligence, and compliance issues, all of which elevate the civil liability and criminal
exposure such companies otherwise factor into their business risk profiles.5 Moreover,
very little of this increased civil liability and criminal exposure has been recognized,
analyzed, or guarded against in any meaningful way.6
3 The distinction made throughout between a SCF “investment” and “transaction” is intended and
important in this context. SCF expresses itself in fundamentally two ways: (a) “the investment”
refers to the kind of investment or business Shari’ah is understood to permit (i.e., equity versus
debt with interest; asset-based versus intangibles such as derivatives or hedging transactions
based upon future contingencies; and commerce in permitted versus prohibited industries) and (b)
“the transaction” refers to the way in which a permitted investment or business transaction is
structured typically through the use of nominate contracts (i.e., an “interest-free” loan may be
structured as a cost-plus sale or sale/lease back). See infra notes 124-126.
4 This memorandum uses the term “facilitator” (or in some cases “professional facilitator”) to
mean the range of legal, accounting, and financial advisor professionals who are intimately
involved in the promotion and structuring of SCF investments and transactions. An example of
this burgeoning cottage industry can be gleaned by looking at the promotional material for the
myriad of professional and business conferences dedicated to SCF. See, e.g., Upcoming Event,
Arab Bankers Ass’n of N. Am., available at
http://www.arabbankers.org/shared/layouts/section.jsp?_event=view&_id=120130_U127360__13
2301 (last visited Jan. 24, 2008).
5 While it is not the purpose of this memorandum to detail the legal risks for the professional
facilitators, there is substantial legal exposure for the legal, accounting, and financial
professionals who provide the knowledge and expertise to develop the financial and legal
instrumentalities of SCF. While “scheme liability” under a Rule 10b-5 private right of action has
been put to rest by Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761
(2008), to the extent that the lawyers get involved in drafting the “representations”, liability will
still apply. See LOUIS LOSS & JOEL SELIGMAN, FUNDAMENTALS OF SECURITIES REGULATION
1329-1332 (2004) (for a discussion on “primary liability” for lawyers under Rule 10b-5); id. at
1465-1469 (for a discussion of the “duty to report evidence of a material violation” under Part
205 to Title 17 of the Code of Federal Regulations promulgated by the SEC pursuant to Section
307 of the Sarbanes-Oxley Act of 2002).
6 This conclusion has been reached by a thorough review of the published proprietary and nonproprietary
information disseminated by many of the financial institutions and the professional
3
Several traits of the SCF industry are particularly problematic. First, and most troubling,
is the Shari’ah “black box” syndrome: U.S. financial institutions and businesses involved
in SCF risk grave consequences by willfully ignoring the endogenous elements of
Shari’ah. Ignoring what Shari’ah is -- both in theory and in practice -- and its intimate
connection to Islamic terror and holy war against the non-Muslim world amounts to
corporate recklessness. Moreover, placing Shari’ah in a black box and treating its
prohibitions as if they were benign secular and objective “screens” ignores the duty of
disclosure of the most important elements of Shari’ah: its purposes and its ultimate
methods. Based on the materiality standards of contemporary securities and fraud laws,
it is clear that a reasonable post-9/11 investor would consider Shari’ah’s connection to
the Law of Jihad, and several Shari’ah authorities’ advocacy of violence and connection
to terrorism, as material to their investment decision.
Second, insofar as U.S. financial institutions participate in and cooperate with the
Shari’ah authorities’ efforts to establish the rules and regulations for the SCF industry,
antitrust issues such as rules collusion are likely to present additional issues of exposure
for those embracing this new industry. And lastly, the current structure of the SCF
industry in which two dozen of the most influential Shari’ah authorities control the way
funds go in and out of the largest financial enterprises in the world creates the
paradigmatic pattern of predicate racketeering activity any aggressive prosecutor or
plaintiff’s lawyer looks for in a RICO cause of action
As a result of these troubling characteristics of Shari’ah-compliant finance, U.S. financial
institutions and businesses have a duty to conduct reasonable due diligence to be certain
that their respective Shari’ah authorities are neither advocating crimes in the name of
Shari’ah nor promoting the material support of terror, either through legal rulings or
through the funneling of “purification” funds to terrorists. Failure to conduct such due
diligence can lead to catastrophic civil and criminal liability.
This analysis is a first of its kind in the published literature. To date, there has been no
focused effort to identify and analyze the implications for civil liability and criminal
exposure for U.S. financial institutions and other businesses engaged in any of the
various manifestations of SCF from a legal and regulatory framework. While some of the
SCF professional and scholarly writings address broad regulatory concerns7, economic
facilitators (i.e., the law firms, accounting firms, and financial advisors who promote SCF as a
business model and marketing niche) and of the published academic and trade journals which
have treated SCF in some detail over the past decade. Some of this material will be referenced
throughout this memorandum as its relevance to disclosure, due diligence, compliance, industry
standards, and best practices are examined.
7 See, e.g., ISLAMIC FINANCE: THE REGULATORY CHALLENGE (Simon Archer & Rifaat Ahmed
Abdel Karim eds., 2007); Ayman H Abdel-Khaleq, Offering Islamic funds in the US and Europe,
INTERNATIONAL FINANCIAL LAW REVIEW, available at
http://www.iflr.com/?Page=17&ISS=16434&SID=515350 (last visited Jan. 24, 2008).
4
risks8, and transactional9 and market-related hurdles10, scant attention has been paid to the
specific civil and criminal liability implications of SCF. Necessarily, this is an
introductory and preliminary effort.11 Each specific area identified in this Article requires
and deserves a detailed treatment by academics and legal professionals, including
government attorneys involved in financial regulation and compliance, policy specialists,
and---most importantly---practitioners advising their clients on the advisability and the
logistics of SCF.
II. Overview of Shari’ah-Compliant Finance:
A. What is SCF?
According to the disclosures and representations of the financial institutions currently
promoting SCF12, Shari’ah compliance means that a particular investment or financial
transaction has been conducted or structured in a way considered “legal” or
“authorized”13 pursuant to Islamic law.14 Compliance with Shari’ah is achieved by
having a Shari’ah authority – either an individual or group of individuals possessing
8 See, e.g., THE POLITICS OF ISLAMIC FINANCE (Clement M. Henry & Rodney Wilson eds.,
2004); see also IBRAHIM WARDE, ISLAMIC FINANCE IN THE GLOBAL ECONOMY (2000).
9 Michael J.T. McMillen, Symposium: Islamic Business and Commercial Law: Contractual
Enforceability Issues: Sukuk and Capital Markets Development, 7 CHI. J. INT’L L. 427 (2007).
10 See, e.g., THE POLITICS OF ISLAMIC FINANCE (Clement M. Henry & Rodney Wilson eds.,
2004); Jane Pollard & Michael Samers, Islamic Banking And Finance: Postcolonial Political
Economy And The Decentring Of Economic Geography, 32 TRANSACTIONS OF THE INSTITUTE OF
BRITISH GEOGRAPHERS 313 (2007), available at http://www.blackwellsynergy.
com/doi/pdf/10.1111/j.1475-5661.2007.00255.x?cookieSet=1 (last visited Jan. 24, 2008).
11 This memorandum does not address in any meaningful way SCF insurance. This is due in large
part to the complex nature of the business of insurance and its regulation and the relatively
untested models for Shari’ah compliant insurance schemes from within the SCF industry itself.
12 A good yet basic recitation of SCF by a U.S. Muslim academic who was the “Scholar-in-
Residence: U.S. Department of Treasury”on SCF is in Mahmoud Amin El-Gamal, A Basic Guide
to Contemporary Islamic Banking and Finance (June 2000), available at
http://www.nubank.com/islamic/primer.pdf (last visited Jan. 24, 2008).
13 In classical and traditional Islamic law, extant and in use to this day by the recognized Shari’ah
authorities, there are essentially five categories of normative assessments: obligatory,
recommended, permitted, discouraged, and forbidden. ENCYCLOPEDIA OF ISLAMIC LAW: A
COMPENDIUM OF THE MAJOR SCHOOLS xxxvii-xxxviii (Laleh Bakhtar ed., 1996).
14 While Shari’ah is often referred to as Islamic law, Shari’ah is according to the Shari’ah
authorities the divine law of Allah which is articulated directly to man through the Qur’an and
indirectly through the canonical stories of Mohammed’s life as told through the Hadith. The
jurisprudential rules developed by the Shari’ah authorities over time to arrive at finite legal
rulings are often referred to as usul al fiqh or the roots of the law and al fiqh or just fiqh is the
corpus of jurisprudential rules and principles. Furu’ is the term used for the positive law rulings
of individual jurists. For a discussion of this in more detail, see infra note 32. For purposes of this
memorandum, the word Shari’ah is used as a collective term to include all of these elements
unless otherwise indicated. This is how most Muslims use the word in the vernacular.
5
authoritative status in matters relating to SCF15 – approve the particular investment or
type of transaction. Most financial institutions retain16 a Shari’ah advisory board, which
typically consists of three or more “Shari’ah scholars” who profess to be recognized as
authorities in SCF.17
According to most financial institutions, SCF is achieved by the avoidance of interest18,
risk (typically understood as uncertainty or speculation)19, and certain types of prohibited
15 There is no universally recognized degree or examination to acquire the status of an SCF
authority. Generally, the discipline in Shari’ah related in part to commerce is termed fiqh al
muamalat and while there are jurists who specialize in this area, the qualifications for such
positions are quite varied. While the industry itself is undertaking to create standards and
structures for uniformity and transparency, it has not been successful to date. An examination of
these issues can be found in Wafik Grais & Matteo Pelligrini, Corporate Governance and Shariah
Compliance in Institutions Offering Islamic Financial Services (World Bank Policy Research
Working Paper No. 4054, 2006), available at http://wwwwds.
worldbank.org/servlet/WDSContentServer/WDSP/IB/2006/11/08/000016406_20061108095
535/Rendered/PDF/wps4054.pdf (last visited Jan. 24, 2008).
16 The manner in which a Shari’ah advisor is employed or contracted for by the financial
institution bears on several of the legal complications and risks discussed herein. See infra notes
48-51 and accompanying text (discussing criminal respondeat superior); see also supra note 14
and accompanying text.
17 The number of Shari’ah scholars sufficiently versed in the disciplines necessary to be gainfully
employed by a “blue chip” financial institution engaged in SCF is quite limited. It is generally
represented that there are only about 20-25 competent Shari’ah scholars who have mastered
Shari’ah, finance, and English well enough to be considered both an SCF scholar and
employable. Richard C. Morais, Don’t Call It Interest, Forbes.com,
http://www.forbes.com/business/global/2007/0723/104.html (last visited Jan. 24, 2008). For the
general problem of the dearth of qualified Shari’ah scholars, see Grais & Pellgrini, supra note 15,
at [page number here] & n.18.
18 In Arabic, the term used is riba, which literally means “increase.” In the past, there has been
debate among Shari’ah authorities and Islamic academic scholars over the prohibition against
riba in financial and commercial transactions. Some scholars point to the fact that the prohibition
against interest in the Qur’an is not simple interest but usurious interest and specifically a default
interest prevalent in pagan pre-Islamic Arabia. Today, the debate is academic because there is
broad consensus that interest of all kinds is forbidden by Shari’ah. For the consensus view of the
prohibition against interest, see FRANK E. VOGEL & SAMUEL L. HAYES, III, ISLAMIC LAW AND
FINANCE: RELIGION, RISK, AND RETURN 71-87 (1998). For a contrarian position, see TIMUR
KURAN, ISLAM & MAMMON: THE ECONOMIC PREDICAMENTS OF ISLAMISM 14 (2004); see also
Alex Alexiev, Islamic Finance or Financing Islamism? 6-7 (The Center for Security Policy,
Occasional Papers Series No. 29, 2007). For a general discussion of how contemporary SCF has
perverted the “intent” of an “authentic” Islamic political economy, see Mahmoud Amin El-
Gamal, “Interest” and the Paradox of the Contemporary Islamic Law and Finance, 27 FORDHAM
INT'L L.J. 108 (2003); Chibli Mallat, The Debate on Riba and Interest in Twentieth Century
Jurisprudence, in ISLAMIC LAW AND FINANCE (Chibli Mallat ed., 1988).
19 The Qur’an forbids gambling or maysir; the Sunna includes gharar or risk in the prohibition.
Since all business includes an element of risk, the jurisprudential task for the Shari’ah authorities
is to take the specific examples found in the canonical literature, such as “Do not buy fish in the
sea, for it is gharar,” and to translate that into principles, then rules and finally into finite rulings
6
industries (relating to activities considered haram or forbidden, such as the pork and
alcohol-beverage industries, pornography, gambling, and interest-based financing).20 In
addition, SCF also includes a focus on “purification”, which has two separate elements.
One is a form of obligatory charitable contribution called zakat, where the act of
supporting the less fortunate is considered a spiritual purification21; the other is the
purification of a Shari’ah-compliant investment or financial transaction that has been
tainted with forbidden revenue, whether from interest, illicit speculation, or a forbidden
commercial enterprise such as the pork industry.22 In the latter meaning of purification,
the forbidden funds must be disgorged by donating the money to an acceptable charity,
but this charitable gift will not count towards a Muslim investor’s zakat requirement.23
A rudimentary understanding of Shari’ah is required to grasp the implications of SCF
relative to U.S. law. To begin, Shari’ah, or the ‘proper way’, is considered the divine will
of Allah as articulated in two canonical sources. The first is the Qur’an, which is
considered the perfect expression of Allah’s will for man. Every word is perfect and
unalterable except and unless altered by some subsequent word of Allah.24 While most of
and contract forms which are considered halal or permitted. See generally VOGEL & HAYES,
supra note 18, at 87-95.
20 While there is general agreement about most of these industries as absolutely forbidden, some
such as the tobacco business and military and defense industries are typically forbidden in SCF in
Western countries but not considered an absolute Shari’ah prohibition. For an exploration into the
Shari’ah motives for forbidding defense industry investments in the West, see infra notes 50, 73-
76 and accompanying text.
21 Zakah (sometimes referred to as zakat), which literally means purification, is a form of
religious tax for assisting the less fortunate and those that “struggle for Allah.” The amount is
between 2.5% and 20%, depending upon the source of the wealth, but it is typically on the lower
end (2.5%) of the scale. The amounts also vary based upon which of the four Sunni schools of
jurisprudence one follows. Shi’a Muslims also follow their own jurisprudence which also
accounts for some of the variation. For a fuller discussion of this religious tax and its use to
support those who “struggle for Allah” or fight against non-Muslims in holy war (i.e., Jihad), see
John D.G. Waszak, The Obstacles to Suppressing Radical Islamic Terrorist Financing, 37 CASE
W. RES. J. INT'L L. 673 (2005).
22 See the extended discussion on purification by a well-known American Shari’ah authority, in
Yusuf Talal DeLorenzo, Shari’ah Supervision of Islamic Mutual Funds, available at
http://www.djindexes.com/mdsidx/downloads/delorenzo.pdf (last visited Jan. 24, 2008).
23 Yusuf Talal DeLorenzo, Dow Jones Universtiy Questions and Answers, Question 32, available
at http://www.central-mosque.com/fiqh/dow.htm (last visited Jan. 24, 2008).
24 For a thorough discussion from a “moderate” Shari’ah authority on the full theological and
jurisprudential analysis of Shari’ah, see MOHAMMAD HASHIM KAMALI, PRINCIPLES OF ISLAMIC
JURISPRUDENCE (2003). For the specific discussion of “abrogration”, which is the juridical view
of latter Qur’anic verses which contradict earlier ones, see id. at 202-227. For an analytical and
objective analysis of Islamic jurisprudence and its implications for Muslim-non-Muslim relations,
see Stephen Collins Coughlin, “To Our Great Detriment”: Ignoring What Extremists Say About
Jihad (with appendices) 83-133 (July 2007) (unpublished thesis, National Defense Intelligence
College).
7
the Qur’an’s 6,236 verses25 are not considered legal text, there are 80 to 500 verses26
considered instructional or sources for normative law. But the Qur’an is only one source
of Allah’s instruction for Shari’ah. The Hadith27, or stories of Mohammed’s life and
behavior, are also considered legal and binding authority for how a Muslim must live.
The Hadith were collected by various authors in the early period after Mohammed’s
death. Over time, Islamic legal scholars vetted the authors for trustworthiness and their
Hadith for authenticity, and there is now a general consensus across all Sunni schools
that there are six canonical Hadith.28 The legal or instructional portions of the Hadith
together make up the Sunna.29 While the Shari’ah authorities from the Shi’a Muslim
25 Because the original Arabic Qur’an is not formally numbered and there are no periods in
classical Arabic setting off one verse from another, Islamic canon typically breaks the 114 suras
or chapters into 6,236 ayat or verses, but other counts are also used.
26 There is also a healthy debate over which verses in the Qur’an are actually legal sources (ayat
al-ahkam) such that laws are directly or indirectly derived from them. According to most
scholars, the debate centers on the context of the appearance of a verse which has within it a
connection to normative or instructional language. Some include all such verses while others only
count those verses which are clearly “legal” in that they address authorized or prohibited
behavior. See, e.g., KAMALI, supra note 24, at 25-27.
27 Hadith is singular for ‘tradition’. Ahadith is the plural. This memorandum uses Hadith as the
collective body of traditions.
28 The Hadith were not formally collected between 100 to 200 years after the death of
Mohammed. See generally THE ISLAMIC SCHOOL OF LAW: EVOLUTION, DEVOLUTION, AND
PROGRESS viii-xii (Peri Bearman, Rudolph Peters & Frank E. Vogel eds., 2005) ; see also
Coughlin, supra note 24, at n.90:
Individuals associated with Muhammad in his lifetime were called “companions.”
Among the numerous companions, the seven most prolific commentators on his life were
Abu Hurrairah ‘Abdur Rahman bin Sakhar Dasi (5,374 Hadith), Abdullah bin Umar bin
Khattab (2,630), Anas bin Malik (2,286), Aisha (2,210), Abdullah bin Abbas (1,660),
Jabir bin Abdullah Ahsan (1,540), and Sa'ad bin Malik Abu Saeed Khudhri (1,540). The
compiled Hadith of these companions did not survive in their original creations but were
passed down and collected by numerous Hadith collectors of varying quality and repute.
Six scholars stand out among Hadith collectors for the reputed accuracy and authenticity
in the selection of Hadith they chose to include as a part of their collections. In precedent
order, the six “correct” collections of the Sunni, also called the “Six Canonical
Collections” (the Sahih Sittah), are the works of Bukhari, Muslim, Abu Dawud, Tirmidhi,
Ibn Maja and Nasa’i. Hence, if a story concerning Muhammad is related through one of
the six “correct” collections and it reliably cites one of the seven companions, a
presumption emerges, verging on irrebuttable, that the texts cited are accurate for the
points being made - as matters of both Islamic theology and law. Because those accounts
are presumed reliable, the Sunna arising from them cannot be construed to contradict the
Qur’an but rather are to be understood as doctrinally authoritative explanations of the
Quranic verses they support: “Whatever the Messenger gives you, then take it and
whatever he prohibits you, then stay away from it.” (Qur’an 59:7)
29 The debate over the role the Hadith should play as the secondary basis for Shari’ah is in fact
the debate between the traditionalists who follow the millennium-old doctrine of the Islamic legal
schools versus the progressives, typically in academia. The former account for the “Shari’ah
authorities” and the latter for university professors who wish to distance themselves and Islam
from the quite bellicose legal-military doctrines derived from the Hadith. The subject is
fascinating and rich with drama but not one this memorandum can take up. The interested reader
8
world also accept the Hadith as authoritative, they differ on the selection of the authors
accepted as authoritative based mostly upon theological grounds.30 For all Shari’ah
authorities, however, the Qur’an is considered the direct revelation of Allah’s will and
therefore primary, while the Sunna is the indirect expression of that will and secondary.
Both sources are considered absolutely infallible and authoritative.
In order to divine the detailed laws, norms, and customs for a Muslim in all matters of
life, the Shari’ah authorities over time developed schools of jurisprudence to guide their
interpretations of the Qur’an and Sunna. While there is broad agreement among the
schools about the jurisprudential rules, important distinctions between the schools result
in different legal interpretations and rulings, albeit typically differences of degree, not of
principle.31 The rules of interpretation and their application to finite factual settings in the
form of legal rulings are collectively termed al fiqh (literally “understanding”). Usul al
fiqh, or the “sources of the law”, is what is normally referred to as jurisprudence.
Technically, Shari’ah is the overarching divine law and fiqh is the way Shari’ah
authorities have interpreted that divine law in finite ways.32 It is important to note,
should begin with Coughlin, supra note 24, at 83 et seq., and then turn to one of the founders of
the academic study of Shari’ah and Islamic jurisprudence, Joseph Schacht. Must reading would
be JOSEPH SCHACHT, AN INTRODUCTION TO ISLAMIC LAW (1982), and JOSEPH SCHACHT,
MUHAMMADAN JURISPRUDENCE (1950). Revisionists abound and two interesting versions are
WAEL B. HALLAQ, A HISTORY OF ISLAMIC LEGAL THEORIES (1997) and WAEL B. HALLAQ, THE
ORIGINS AND EVOLUTION OF ISLAMIC LAW (2005) on the one hand; and M. MUSTAFA ALAZAMI,
ON SCHACHT’S ORIGINS OF MUHAMMADAN JURISPRUDENCE (1996) on the other hand.
Useful also would be KAMALI, supra note 24.
30 Shi’a Islam differs from Sunni Islam theologically on who they consider to be legitimate
successors to Mohammad’s reign as leader of the Muslim Umma or nation. This has
jurisprudential consequences because Shi’a Muslims, who await the return of the Fourth Imam or
Caliph following Mohammed, consider their Imams who have followed in the Fourth Imam’s
footsteps to be his stand-in until his return and as such they share his infallibility. Thus, the
leading contemporary Shi’a Imams are considered by their followers as inerrant and their legal
rulings take on the perfection one would expect from inerrant beings. See Coughlin, supra note
24, at [page number here] n.52 and accompanying text.
31 As noted, the Shari’ah authorities developed different schools of legal interpretation. These
schools are called maddhahib (or maddhab in the singular form). Early in their development,
there were many schisms and new schools but over time, the main body of legal scholarship and
almost all Shari’ah authorities have long come to recognize only four extant schools among
Sunni Muslims and one dominant school (some cite two) among Shi’a Muslims. While there are
important jurisprudential and theological differences between the Sunni and Shi’a, see supra note
29, and indeed between the schools themselves within the respective Sunni and Sh’ia traditions,
the specific rulings among all schools on the fundamental issues regarding the purposes of
Shari’ah, the point of the individual Muslim’s life, and the integrity and unity of the Muslim
nation as a whole and the methodologies to achieve those ends are remarkably consistent, see
generally Coughlin, supra note 24.
32 Furu’ is the Arabic word most often associated with positive law or the particular rulings in any
given case. See VOGEL & HAYES, supra note 18, at 23-24; see also M. Cherif Bassiouni & Gamal
M. Badr, The Shari’ah: Sources, Interpretation, and Rule-Making, 1 UCLA J. ISLAMIC & NEAR
E.L. 135 (2002). For a discussion of furu’ and usul al-fiqh, see Wael B. Hallaq, Usul Al-Fiqh:
Beyond Tradition, 3:2 J. ISLAMIC STUD. 172-202 (1992), reprinted in Law and Legal Theory.
9
however, that the word Shari’ah appears only once in the Qur’an in this context33, yet it
has gained currency in the Islamic world by virtue of the Shari’ah authorities over more
than a millennium creating a corpus juris (i.e., al fiqh) based upon their interpretative
understandings of the Qur’an and Sunna. As such, this Article uses the word Shari’ah to
mean all of Islamic jurisprudence, doctrine, and legal rulings, much as it is used in the
vernacular by the typical Shari’ah-adherent Muslim.
Prior to the twentieth century, there was no discipline termed Shari’ah-compliant
financing or even a Shari’ah sub-code regarding commercial transactions.34 There are
rulings by Shari’ah authorities authorizing certain contract forms dating back hundreds of
years, but as late as the 1900s there was still some debate among Shari’ah authorities
whether the prohibition against interest was absolute or just against usurious interest.
When contemporary Islamic political thinkers began to confront the collapse of the
Ottoman Empire after the First World War and the intrusion of Western modes of social,
political, and commercial life into the heart of the Muslim world, Shari’ah authorities
followed their lead and began to issue legal rulings to confront this new reality.35
Beginning with the early political-theological writings of men such as Maulana Abul Ala
Mawdudi---who argued for an Islamic political resurgence and a unique Islamic political
economy---Shari’ah authorities followed suit by issuing authoritative legal rulings
forbidding interest on deposits and calling for the establishment of “Islamic banks”. Over
time, these rulings have incorporated prohibitions against transactions considered too
uncertain or speculative and also rulings to prevent Muslims from investing in businesses
engaged in un-Islamic behavior.36 The development of these rules and the formalization
of SCF have matured over the past three decades so that today there are entire university
departments in the Middle East, Asia, and even in Western universities dedicated to the
33 See Qur’an 45:18. But see Qur’an 5:48, where a variation of the word appears and has the
meaning of the ‘proper way’; while some might argue that the word appears in yet other
variations, the first of these two are the typical verses cited where the word is used in the sense of
a legally proper path.
34 The legal verses of the Qur’an are typically broken down into those verses dealing with
religious rites and worship (ibadat) and those dealing with civil relations including commerce,
political life, and the Law of Jihad (mu’amalat). KAMALI, supra note 24, at 26. What is confusing
to many is that most academics writing on the subject of SCF define mu’amalat as civil or
commercial relations giving the impression that there is in fact some sub-code of strictly
commercial matters devoid of broader implications. See, e.g., Yusuf Talal DeLorenzo & Michael
J.T. McMillen, Law and Islamic Finance: An Interactive Analysis, in ISLAMIC FINANCE, supra
note 7, at 142. But cf. VOGEL & HAYES, supra note 18, at 301, where the “Glossary” defines
mu’amalat as “dealings or transactions among human beings; compare ‘ibādāt.” Thus, while the
“glossary” definition is technically correct and properly juxtaposes mu’amalat against ibadat, the
reader who would need such a glossary is not likely to understand that mu’amalat is as much the
Law of Jihad as it is commercial dealings.
35 See generally supra note 18. For the “socio-economic” impetus for SCF, see Walid S. Hegazy,
Symposium: Islamic Business And Commercial Law: Contemporary Islamic Finance: From
Socioeconomic Idealism To Pure Legalism, 7 CHI. J. INT'L L. 581 (2007).
36 See generally DeLorenzo & McMillen, supra note 34, at 132-197.
1 0
study of SCF.37 Most observers connect this recent development to the emphasis of
Shari’ah in the oil-producing Arab states and their wealth-driven influence throughout
the Muslim world and the West.38
Effectively, SCF is an attempt to embrace modern interest-based commerce and finance,
but to do so within a framework of Shari’ah-approved structures. For example, while
almost all Shari’ah authorities forbid any transaction or investment which provides for
interest income, SCF rules allow for interest in two ways. One way is to rule that a
Muslim can invest in a permitted business that earns or pays interest but only if the
amount is below a maximum level.39 Any profit earned by the Muslim from that interest
component, however, must be purified by contributing that portion to a Shari’ahapproved
charity.40 A second way to accommodate modern commercial transactions is to
structure the forbidden transaction within Shari’ah-approved contract forms. These
nominate contracts are based upon contract forms found in the classical rulings of the
Shari’ah authorities prior to the advent of contemporary finance. Thus, a loan might be
structured as a “cost-plus sale” where the lender buys the property and immediately sells
it back to the borrower for a “profit”. This profit is the interest component in the typical
loan transaction. The purchase price with the profit component included can be paid over
time to resemble an amortized loan repayment schedule. Other forms are available to deal
with interest and also with unduly speculative transactions, including sale-lease back
contracts, and partnerships with variations and combinations. For the more complex
transactions, these Shari’ah approved nominate contracts are often pieced together and
used in combination to arrive at a Shari’ah-compliant modern commercial deal.41
37 See Muslim-Investor.com, Resources -- Education/Curricula in Islamic Finance, Education and
Banking, available at http://muslim-investor.com/mi/education.phtml (last visited Jan. 25, 2008)
(listing university departments).
38 See generally WARDE, supra note 9, who theorizes of a “First and Second Aggiornamento” to
suggest a first movement driven by a centralization of power and influence flowing from Arab oil
wealth and a second movement driven by decentralized social, political, and financial
constituencies. For a media rendition of the oil wealth-driven industry, see Wayne Arnold,
Islamic Banking Rises on Oil Wealth, Drawing Non-Muslims, INT’L HERALD TRIB., Nov. 22,
2007, available at http://www.iht.com/articles/2007/11/22/business/islamic.php (last visited Jan.
25, 2008).
39 The first order of business for determining whether a business is Shari’ah compliant is to make
certain that it is not involved in a “vice” industry such as interest-based financing, the pork
industry, various forms of the entertainment industry, and gambling. The question for Shari’ah
authorities is how much “involvement” in a prohibited business amounts to a violation of
Shari’ah such that an investor must not invest in that company. The same question applies to a
permitted business that might earn interest on deposits or accounts payable and pay interest on
debt: How much interest is too much interest? For a discussion of the Shari’ah authority opinions
on this matter by one of the leading Shari’ah authorities, see Nizam Yaquby, Participation and
Trading In Equities of Companies Which Main Business Is Primarily Lawful but Fraught with
Some Prohibited Transactions, Address at the Fourth Harvard Islamic Finance Forum, Harvard
University (Sept. 30-Oct 1, 2000), available at
http://www.djindexes.com/mdsidx/downloads/yaquby.pdf (last visited Jan. 25, 2008).
40 See DeLorenzo, supra note 22.
41 See DeLorenzo & McMillen, supra note 34, at 143-150. Since the development of SCF, the
debate among Islamic, economic, and Shari’ah scholars continues over the propriety of this new
1 1
B. Why is SCF important?
As a burgeoning industry, SCF is touted as one of the fastest growing sectors in the
global financial markets.42 Total funds committed to SCF investments is estimated to be
$800 billion worldwide43, with $200 billion of assets under management in Shari’ahcompliant
banks.44 Annual growth in this sector is estimated at between 15-20%45, based
upon current trends fueled mainly by profits in the Muslim oil- and gas-producing
countries and by a worldwide Muslim population reported to be the fastest growing
among the world’s major religions.46
Within the SCF market, Shari’ah-compliant bonds, known in Arabic as sukuk47, are the
most explosive segment driven by huge petro-dollar profits creating enormous sovereign
wealth and liquidity. As of the end of the second quarter 2007, outstanding Shari’ahfield
of Shari’ah scholarship. Some argue that the industry is nothing more than form over
substance and an abuse of Shari’ah. Others contend that SCF is a convoluted way for Shari’ah to
effect its purposes in modern Western financial institutions. For the former, the debate is over the
perversion of Shari’ah and its pre-modern ethic and economic principles. This group of critics
would prefer that Shari’ah be used to modify the existing political economies to move away from
interest-based debt and highly speculative and leveraged derivative transactions. For the latter
group of critics, SCF is more than just an attempt to mollify the Shari’ah authorities; it is a
“Trojan Horse” to legitimatize and to institutionalize Shari’ah, the purpose of which is the
destruction of Western societies as such. For an example of the former group, see Haider Ala
Hamoudi, Muhammad’s Social Justice or Muslim Cant?: Langdellianism and the Failures of
Islamic Finance, 40 CORNELL INT'L L.J. 89; El-Gamal, supra note 18. For the latter group, see
KURAN, supra note 18; Alexiev, supra note 18.
42 Drake Bennett, The Zero Percent Solution, BOSTON GLOBE, Nov. 4, 2007, available at
http://www.boston.com/news/education/higher/articles/2007/11/04/the_zero_percent_solution/
(last visited Jan. 25, 2008).
43 Alexiev, supra note 18, at [page number here] & n.1.
44 Islamic Banking---Status of Islamic Banking, Institute of Islamic Banking and Insurance,
available at http://www.islamic-banking.com/ibanking/statusib.php (last visited Jan. 25, 2008).
45 See Mohammed El Qorchi, Islamic Finance Gears Up, 42 Fin. & Dev., Dec. 2005, available at
http://www.imf.org/external/pubs/ft/fandd/2005/12/qorchi.htm (last visited Jan. 25, 2008).
Growth is reported to have reached 30% annually. See Karina Robinson, Islamic Finance Is
Seeing Spectacular Growth, INT’L HERALD TRIB., Nov. 5, 2007, available at
http://www.iht.com/articles/2007/11/05/business/bankcol06.php (last visited Jan. 25, 2008).
46 Gayle Young, Fast Growing Islam Winning Converts in Western World, CNN Interactive
News, http://www.cnn.com/WORLD/9704/14/egypt.islam/ (last visited Jan. 25, 2008). The
Executive Vice President and General Counsel of the Federal Reserve Board of New York cited a
White House report that Islam is the “fastest growing faith in the United States.” Thomas C.
Baxter, Jr., Executive Vice President & Gen. Counsel, Fed. Reserve Bank of N.Y. Welcome
Speech to the Seminar on Legal Issues in the Islamic Financial Services Industry (March 1,
2005), available at http://www.newyorkfed.org/newsevents/speeches/2005/bax050301.html (last
visited Jan. 25, 2008).
47 Sukuk in Arabic is plural for bonds; sak is the singular form.
1 2
compliant bonds totaled $80 billion, with another $37.3 billion issued in the third quarter-
--double the amount issued during the same period the previous year.48
All of this growth, underwritten mostly by the mobile, highly liquid capital flowing out of
the GCC states49, has generated an industry of financial institutions, law firms,
accounting firms, financial advisors, and money managers establishing domestic and
international links with the key investment figures in the GCC states in an effort to
exploit the opportunity for substantial profits.50 This enthusiasm has been translated to
domestic U.S. financial industries in many ways.51 U.S. financial institutions seek to
48 Mark Bendeich, Islamic Finance: Safe Haven or Irrational Exuberance? REUTERS, Dec. 10,
2007, http://www.reuters.com/article/bankingfinancial-SP-A/idUSKLR27708220071210 (last
visited Jan. 25, 2007). Growth in this industry is best illustrated graphically. For growth data on
Shari’ah compliant bonds, see Appendix A. To put the Shari’ah compliant bond issuance in
context, the total net issuances of all international bonds and notes for the third quarter of 2007
was $396 billion, which represents a significant downturn in worldwide demand for such debt
instruments. See BANK FOR INTERNATIONAL SETTLEMENTS, BIS QUARTERLY REVIEW 19-21,
Dec. 2007,,available at http://www.bis.org/publ/qtrpdf/r_qt0712.pdf (last visited Jan. 25, 2008).
That Shari’ah compliant bonds were showing spectacular growth in the same quarter and
representing approximately 10% of worldwide demand speaks volumes for the popularity and the
liquidity of this particular market segment.
49 The principal oil-producing Muslim states are located in and around the Persian Gulf: Bahrain,
Kuwait, Quatar, Oman, Saudi Arabia, the United Arab Emirates, Iraq, and Iran. These countries,
sans Iraq and Iran, formed the Gulf Cooperation Council in February 1981. See Council Charter
of the Secretariat General of the Cooperation Council for the Arab States of the Gulf, available at
http://www.gcc-sg.org/eng/index.php?action=Sec-Show&ID=1 (last visited Jan. 25, 2007).
50 For some of the promotional literature naming several of the “facilitators,” see, e.g., John
Butcher, Shariah Funds Inc Introduces the First Islamic Hedge Fund Aided by Scholars, HEDGE
FUNDS REV., available at http://www.shariahfunds.com/news/images/Hedge_Funds-Rev.pdf.
For specifically offices of such international law firms as Patton Boggs in Qatar, see the firm’s
Internet site, http://www.pattonboggs.com/Locations/Office.aspx?office=4 (last visited Feb. 28,
2008). For Patton Boggs promotional material indicating the law firm is also a registered agent
for lobbying on behalf of the Saudi Arabian government, see Patton Boggs LLP, Attorneys at
Law, http://www.pattonboggs.com/middleeast/ (last visited Feb. 28, 2008). The law firm of King
and Spaulding also highlights its activities in the area on its Internet site. See King & Spaulding,
http://www.kslaw.com/portal/server.pt?space=KSPublicRedirect&control=KSPublicRedirect&Pr
acticeAreaId=141&us_more=0 (last visited [date]); see also Brian O’Connell, Wealth
Management: Gulf’s Super Rich Return Home, Meed, Dec. 21, 2007 (updated Jan. 9, 2008),
available at
http://www.meed.com/bankingandfinance/specialreport/2007/12/gulfs_superrich_return_home.ht
ml.
51 For GCC sovereign wealth funds purchasing U.S. assets, see David Enrich, Oil-Rich Persian
Gulf Countries Show Growing Financial Clout, DOW JONES NEWSWIRES, Oct. 22, 2007,
available at http://www.zawya.com/story.cfm/sidDN20070920015851 (last visited Feb. 4, 2008).
For the push to establish SCF in the U.S., see generally Wayne Arnold, Adapting Finance to
Islam, N.Y. TIMES, Nov. 22, 2007, available at
http://www.nytimes.com/2007/11/22/business/worldbusiness/22islamic.html?ei=5087&em=&en=
d6f0821c05a1d02f&ex=1195880400&pagewanted=all (last visited Jan. 25, 2008).
1 3
underwrite Shari’ah-compliant bond issuances domestically and globally;52 Dow Jones
and Company53 and Standard & Poor’s54 have both established Shari’ah-compliant
indexes that screen equities based upon software filters meant to eliminate Shari’ah-noncompliant
businesses; Shari’ah-compliant U.S.-based managed equity funds55 and offshore
hedge funds56 managed or advised by entities related to U.S. financial institutions
have been established and can now peg their performances against these indexes; and
U.S. banks have begun to offer Shari’ah-compliant home loans and other credit
facilities57 with federal banking authorities opining about their legality and at least one
state tax authority issuing a ruling on the tax implications of a Shari’ah-compliant
transaction58.
C. The Need for Heightened Scrutiny
When investing or entering into financial transactions, why should adherence to the
normative principles of Shari’ah require any special or heightened scrutiny in relation to
civil liability or criminal exposure? The most immediate answer is that, according to the
proponents and practitioners of SCF, Shari’ah is not simply an approach to interest-free,
ethical investing. Instead, SCF is invariably described by SCF proponents, practitioners,
52 Karen Lane, Islamic-Bond Market Becomes Global By Attracting Non-Muslim Borrowers,
WALL ST. J., Nov. 16, 2006, available at
http://online.wsj.com/article/SB116361223362324035.html (last visited Jan. 25, 2008); see also
Press Release, Dow Jones, Dow Jones Indexes and Citigroup To Launch First Islamic Bond
Index (Mar. 6, 2006), available at
http://www.dj.com/Pressroom/PressReleases/Other/US/2006/0306_US_DowJonesIndexes_1095.
htm (last visited Jan. 25, 2008).
53 See Dow Jones Islamic Market Indexes, Dow Jones Indexes, available at
http://www.djindexes.com/mdsidx/?event=showIslamic (last visited Jan. 25, 2008).
54 See STANDARD & POOR’S, S & P SHARIAH INDICES, available at
http://www2.standardandpoors.com/spf/pdf/index/SP_Shariah_Indices_Methodology_Web.pdf
(last visited Jan. 25, 2008).
55 See Index Comparisons, Dow Jones Islamic Fund, http://www.investaaa.com/cgibin/
client_product.cgi?member=55&product_id=527 (last visited Jan. 25, 2008).
56 See Joanna Slater, Growing Interest: When Hedge Funds Meet Islamic Finance, WALL ST. J.,
Aug. 9, 2007, available at
http://online.wsj.com/article/SB118661926443492441.html?mod=todays_us_page_one (last
visited Jan. 25, 2008).
57 See, e.g., Islamic Finance, Devon Bank, http://www.devonbank.com/Islamic/ (last visited Jan.
25, 2008) (Chicago-based Devon Bank internet site promoting its Islamic finance products).
58 See, e.g., Shirley Chieu, Islamic Finance in the United States: A Small But Growing Industry,
Chicago Fed Letter No. 214, May 2005, available at
http://www.chicagofed.org/publications/fedletter/cflmay2005_214.pdf (last visited Jan. 25, 2008);
Office of the Comptroller of the Currency, Interpretive Letter No. 806, Oct. 17, 1997, available at
http://www.occ.treas.gov/interp/dec97/int806.pdf; Office of the Comptroller of the Currency,
Interpretive Letter No.867, June 1, 1999, available at
http://www.occ.treas.gov/interp/nov99/int867.pdf; see also State of New York Commissioner of
Taxation and Finance Advisory Opinion Petition No. M010821A, Jul. 26, 2002, available at
http://www.tax.state.ny.us/pdf/advisory_opinions/real_estate/a02_4r.pdf (last visited Jan. 25,
2008).
1 4
and scholars as the contemporary Islamic legal, normative, and communal response to the
demands of modern finance and commerce.59
As understood on its own terms or by the many constituencies who interpret it, Shari’ah
is not predicated upon a personal or subjective understanding of what it means to be a
Muslim. Neither is it simply an objective formal law or behavioral code regulating
finance and commercial transactions. Shari’ah has been described as “holistic”60, as
“designating good order, much like nomos”61, and definitively by Joseph Schacht, the
founding father of modern scholarship regarding Islamic jurisprudence, as “[t]he sacred
law of Islam [which] is an all-embracing body of religious duties rather than a legal
system proper; it comprises on an equal footing ordinances regarding cult and ritual, as
well as political and (in the narrow sense) legal rules.” 62
In one of the first academic presentations of this new industry, Professors Frank Vogel
and Samuel Hayes explain that Shari’ah is not a personalized, subjective, pietistic
approach to Islam, but an institutionalized legal-political-normative doctrine and
system.63 This classical understanding of Shari’ah has been echoed by a leading
professor of finance in Australia and a senior official in the Bahrain Ministry of Finance
and National Economy.64
Shari’ah is therefore not a religious legal code in which offending areas of law can be
isolated and removed from a cauterized corpus juris. Instead, Shari’ah is understood by
59 See generally VOGEL & HAYES, supra note 18. SCF is “legal” in the sense it includes aspects
of binding law, especially in Muslim countries where Shari’ah is considered both constitutional
and statutory, such as Saudi Arabia, Iran, and Sudan; “normative” in the sense that Shari’ah is
considered an all-encompassing way of life; and “communal” in the sense that communities of
Muslims have in fact embraced Shari’ah as authoritative at some level.
60 Bassiouni & Badr, supra note 32, at 135.
61 WARDE, supra at note 9, at 33.
62 JOSEPH SCHACHT, AN INTRODUCTION TO ISLAMIC LAW 1 (1982).
63 VOGEL & HAYES, supra note 18, at 23.
64 MERVYN K. LEWIS & LATIFA M. ALGAOUD, ISLAMIC BANKING 24 (Edward Elgar ed., 2001).
While the authors attempt to “tone down” this absolute statement of Shari’ah by suggesting that
as a practical matter Shari’ah has in fact lived side-by-side with secular law and in some cases
even incorporated it into Shari’ah, they honestly but almost unnoticeably add the following to
their effort to soften Shari’ah: “The continuation of a custom of a particular place or community
is allowable under Islamic law, and may in fact be assimilated into the law, as were many of the
customs of the Arabs. To be permissible a custom must not be contrary to revealed
injunctions, and this point remains highly controversial in some areas, for example the treatment
of women.” Id. at 25. What the authors mean by “revealed injunctions” means any legal ruling of
Shari’ah authorities where there is consensus among the authorities that the ruling is based on an
explicit verse in the Qur’an or Sunna. See infra note 70 and accompanying text (discussing
jurisprudential force of “consensus”). What is intriguing is that of all of the fixed unalterable laws
of Shari’ah, the authors are concerned about the treatment of women. While many certainly argue
that Shari’ah demeans and subordinates the Muslim woman, one might have thought that the
fixed death penalty for an apostate – a Muslim who wishes to leave Islam – would have captured
their concern sufficient for articulation. Apparently, it is not, in the authors’ views, “highly
controversial” among the Shari’ah faithful.
1 5
authorities and scholars as an indivisible “way of life”65 which informs a Shari’ahadherent
Muslim’s entire being and identity as a Muslim66, including his relationship to
his family, the poor, the stranger, the visitor, national political life, the Muslim Umma (or
nation), religious ritual, business and financial dealings, and the enemy.67 While Shari’ah
includes more than a millennium of legal decisions developed through Islamic
jurisprudence and informal code-like compilations developed by the different “schools of
jurisprudence”68, Shari’ah proper is the overarching authoritative architecture for all
Islamic jurisprudence and the specific legal decisions which make up the corpus of a
juristic body of Islamic dictates and norms.
Understood in its proper context, anything deemed Shari’ah-compliant by Islamic legal
authorities must first and foremost be within the gestalt of Shari’ah. It is not enough,
according to Shari’ah, that a Muslim conducts his own affairs and business according to
some narrow definition of “Islamic ethical business practices.” For a Shari’ah-adherent
Muslim to conduct his business and financial affairs properly, he must not knowingly
promote through his business dealings any forbidden action or violation of a fundamental
precept of Shari’ah or the legal rulings promulgated thereunder. This is what the scholars
mean when they describe Shari’ah as “holistic” or a fully integrated religious, moral, and
legal code.69
It has been the duty of the Shari’ah legal scholars over the ages to understand these
precepts and to apply them to new and changing circumstances. The degree to which
individual Muslims or the political powers ruling over them have adhered to Shari’ah as
determined by the authoritative Islamic jurists has varied tremendously. It can be said
with some historical confidence that Shari’ah has been honored more in the breach than
in its observance.70 But the breaches have not diminished the absolute authority of
65 The literal meaning of Shari’ah is “the way” -- especially to the source of water (i.e., life).
66 See, e.g., DeLorenzo & McMillen, supra note 34, at 136-137.
67 Coughlin, supra note 24.
68 See supra note 31. For a detailed discussion of the schools of jurisprudence, see id.
69 See generally DeLorenzo, supra note 22.
70 There is no shortage of academic literature on the political and religious turmoil that existed in
the Muslim empires from soon after the death of Mohammed and the battles between the
“traditionalists” who sought a Shari’ah-centered political world and those who opposed it for one
reason or another. A good, deep history of Islam may be found in MARSHALL G. S. HODGSON,
THE VENTURE OF ISLAM: CONSCIENCE AND HISTORY IN A WORLD CIVILIZATION, 3 vols. (1974).
And, of course, the required reference to BERNARD LEWIS, THE MIDDLE EAST: A BRIEF HISTORY
OF THE LAST 2,000 YEARS (1995). For the narrative of the failures in Islamic history for the
political leaders to abide by Shari’ah from the “traditionalist” vantage, see SAYYID QUTB,
SOCIAL JUSTICE IN ISLAM (2000). For the classic statement on this “theory” versus “practice” and
the dominant role of Shari’ah authorities to determine the theory and even the practice when
Shari’ah is put into practice, see Joseph Schacht, supra note 62. For the lament of a “moderate”
Shari’ah academic scholar who would like to see Shari’ah and usul al-fiqh modernized so that it
might be used to govern modern societies, he suggests that the failure of Shari’ah to keep pace
with modernity was precisely because it often was not fully integrated into Islamic society but
rather developed as a private affair among Shari’ah authorities. KAMALI, supra note 24, at 500-
521.
1 6
Shari’ah and its jurisprudence, as articulated by Islamic legal scholars and the institutions
they have established over the past 1200 years, to define the legal limits of permitted and
proscribed behavior among the hundreds of millions of Muslims worldwide who consider
Shari’ah a way of life, as much religion and moral guide as civil and criminal code.71
The implication of this fuller understanding of Shari’ah is that one cannot speak of
Shari’ah-compliant finance, business, or economics in the U.S. without understanding
Shari’ah as articulated by the Shari’ah authorities and its ramifications for the U.S.
investor. This is especially true given the legal implications surrounding the duty to
disclose for financial institutions contemplating an SCF transaction. Consider, for
example, a mutual fund that promotes itself as Shari’ah-compliant. Having licensed the
use of the Dow Jones Islamic Index (“DJII”), which utilizes a software filtering protocol
determined to be Shari’ah-compliant by the Shari’ah advisory board retained by Dow
Jones & Company, the mutual fund selects a subset of the indexed listed equities for its
portfolio. A careful reading of the DJII’s marketing material, and of the registration
statements filed by DJII-utilizing funds, indicates that disclosure issues abound.72
Specifically, in the registration statement filed with the Securities and Exchange
Commission for one of the first such funds, the Dow Jones Islamic Market Index
Portfolio73 (“Dow Jones Islamic Portfolio Fund”), other than a reference to certain
“Shari’ah screens” or “filters” limiting the universe of acceptable investments, nothing is
said of Shari’ah. For the investing public, all it learns about Shari’ah in the context of
this Shari’ah-compliant mutual fund is that equities of companies involved in interestdriven
profits, companies dealing with commodities such as alcohol or pork, or
companies engaged in the “vice” industries such as entertainment and gambling, are
prohibited. In addition, the standard disclosures include references to various financial
ratios that work to eliminate companies that might generate too much interest income on
its cash reserves or pay too much interest on its debt. In other words, the DJII and the
mutual funds utilizing such an index appear in many ways like other “socially responsible
investing” or customized “values-based” and “faith-based” indexes.
But this is hardly the case. In a “secular” or even “ideologically” driven values-based
index, a screen that filters out all tobacco and weapons businesses is just that. Even if the
background social or political activism animating the screen is a “smoke-free
71 This is evident in SCF itself. The sole authorities for determining Shari’ah compliance or even
what is ”Islamic” regarding finance and commerce are the traditional Shari’ah scholars.
Whatever criticism some critics might have of the “Islamist” bent of SCF, there is no serious
challenge to the absolute authority of the traditionalists in this discipline. See, e.g., VOGEL &
HAYES, supra note 18, at 9-10, 23.
72 The fundamental standard regarding disclosure of risks and other pertinent information is
whether the risks are material and whether any other information would be material to a
reasonable investor. For a more thorough discussion of materiality and other disclosure issues,
see infra Part IV.C.1.
73 This fund was begun in 1999 and liquidated in 2002. For access to its SEC filings, see
http://www.sec.gov/cgi-bin/browseedgar?
action=getcompany&CIK=0001088654&owner=include&count=40 (last visited Feb. 4,
2008).
1 7
environment” and “pacifism,” the screen is marketed only as a screen that filters out
tobacco and weapons industries. It does not purport to be based upon some universal
theological-moral-legal system existing independently of the filters.74
When the mutual fund, however, markets its product as “Islamic” or “Shari’ahcompliant”,
it is making a claim that goes well beyond the disclosed screens or filters,
even if all that is applied to make it “Islamic” or “Shari’ah-compliant” is the filters
themselves. A cursory reading of the registration statement filed pursuant to the
Investment Act of 194075 for the Dow Jones Islamic Portfolio Fund suggests that the
lawyers tasked with writing the risk section of the document understood this reality, at
least at some rudimentary level76, and sought to eliminate the problem with one broad
brushstroke:
The investment objective of the Dow Jones Islamic Market Index Portfolio
(the "Portfolio") is to seek long-term capital gains by matching the
performance of the Dow Jones Islamic Market Index(SM) (the "Index") – a
globally diversified compilation of equity securities considered by Dow
Jones' Shari’ah Supervisory Board to be in compliance with Shari’ah
principles. (Emphasis added.)77
Notwithstanding representations throughout the registration statement that various
practices of the fund will comply with “Shari’ah principles”, which are nowhere
74 Thus, even if it promoted itself as ethical equity-based investing, if it was based upon Shari’ah,
the disclosure issue would remain. Further, it is different than the so-called Catholic indexes.
Even in the case of the “Catholic Values” funds, there is no representation that there is an
underlying legal code requiring certain investment behavior by adherent Catholics. Instead, the
funds follow “Catholic values” as they and their advisors determine them to be based upon the
doctrine of the Catholic Church but they are just as clear that even if their “Catholic advisors”
were to determine a company was not suited to these values, there is no requirement either by the
rules of the fund or by the Catholic Church that such companies not be included in the fund. In
other words, the Catholic funds are like other truly “values-based” funds where like-minded
individuals agree on certain standards.
75 Investment Company Act of 1940, Pub. L. No. 76-768, 54 Stat. 789.
76 The lawyers’ imputed knowledge is “rudimentary” because very few of the lawyers acting as
facilitators in the SCF industry fully understand or acknowledge what Shari’ah is beyond
thinking of it as just another “value-based screen.”
77 For the Dow Jones Islamic Market Index Portfolio’s Registration Statement filed pursuant to
the Investment Company Act of 1940, Part B, Item 12, see Dow Jones Islamic Market Index
Portfolio, Registration Statement (Form N-1A), available at
http://www.sec.gov/Archives/edgar/data/1088654/0000935489-99-000014.txt (last visited Jan.
25, 2008). In addition, in Part A of the of the registration statement, there are warranty
disclaimers relative to the DJII, the most important of which is:
Although Dow Jones uses reasonable efforts to comply with its guidelines regarding the
selection of components in the Dow Jones Islamic Market Index, Dow Jones disclaims
any warranty of compliance with Shariah law or other Islamic principles . . . .
While this might insulate Dow Jones from a claim of breach of warranty, it does not address the
failure to disclose material risks relative to the very real problem of competing Shari’ah
authorities.
1 8
articulated in a material way, the language in this section intends to sweep Shari’ah under
the rug by reducing “Shari’ah principles” to whatever the Dow Jones Shari’ah
Supervisory Board says they are. There are, however, a plethora of risk factors
specifically associated with anything pegged to Shari’ah compliance that such a
statement fails to capture. Fundamental disclosure issues for a reasonable investor would
be: What is Shari’ah? Does applying Shari’ah “principles” pose any unique reputational
or financial risks for the investment or might it actually pose a risk for the physical safety
of the U.S. investor? In other words, if Shari’ah is hostile to Western political and
financial institutions, would that be important for a U.S. investor to know prior to
investing in a business which promotes Shari’ah-compliant investing?
The point of this example is not to analyze the liability exposure of the registration
statement of the now defunct Dow Jones Islamic Portfolio Fund, but rather to illustrate
how marketing an investment product as Shari’ah-compliant incorporates a set of factual
predicates, many of which are material to the investment decision. According to the
Shari’ah authorities themselves, Shari’ah -- of which SCF is only a small, integrated
component -- is more than just a half-dozen filters operating in the background to
eliminate interest, speculation, and vice. Rather, it is a motivating force and mark of
Muslim identification for hundreds of millions of Muslims throughout the world, a
corpus juris that incorporates a 1200-year old history of jurisprudence, of
institutionalized legal schools with published legal decisions and other scholarly writings,
together with more than a millennium of religious and political implications, all of which
have generated a body of literature on the import of Shari’ah in the ancient and
contemporary world.
These realities comprise a dangerous minefield for the naïve or willfully ignorant
financial institution seeking to capitalize on the alluring new universe of investment
vehicles marketed to Shari’ah adherents. This minefield includes questions these
financial institutions and their professional facilitators have not even begun to ask, much
less answer.78 This Article begins the analysis and the necessary discussion of SCF’s
implications for the U.S. financial industry, the professionals advising their clients on
SCF, and the policy-makers in and out of government. Policy-makers especially have an
78 The following represent just a few of the queries one might expect to be addressed, all of which
force the issue of what does the Shari’ah in Shari’ah compliant finance really mean: Is a
company dedicated to atheism or polytheism Shari’ah compliant even if it passes the “objective”
screens discussed in the text above? What about abortion clinics? Is a company that otherwise
passes the publicly-disclosed filters remain Shari’ah compliant even if it is owned by or
domiciled in the territory of the enemies of the Muslim nation (i.e., an Israeli-owned or domiciled
company)? When the Dow Jones Islamic Index publicizes that weapons manufacturers are
forbidden, does Shari’ah in fact forbid weapons manufacturing by Muslims for Muslim nations?
Would it be material to a reasonable U.S. investor to know if the answers to any of these
questions is “no”? What would happen if the U.S. went to war against a major Shari’ahcompliant
Muslim nation and, as a result, the GCC states together with most of the authoritative
Shari’ah scholars in the world declare the war an act of war against the entire Muslim nation?
Will this declaration of war affect the Dow Jones’ Islamic Index filters? Would any company
owned by non-Muslim U.S. citizens be Shari’ah-compliant under those circumstances?
1 9
obligation to consider the ominous implications for U.S. national and financial security of
a fully integrated Shari’ah-compliant financial industry.
III. Toward an Analytical Taxonomy
A. The Lawyer’s Role in SCF
As indicated above, Shari’ah-compliant financing is nomenclature describing the
contemporary Islamic legal, normative, and communal response to the demands of
modern day finance and commerce.79 Shari’ah-adherent Muslims desire to maintain their
commitment to the normative demands of Shari’ah. At the same time, they wish to
participate in the benefits and opportunities afforded by investment in international and
Western financial structures that are neither Shari’ah-centric nor Shari’ah-compliant, at
least according to the overwhelming majority of Shari’ah authorities.80
Transactional lawyers are often required to opine on the transaction’s compliance with
existing law and the enforceability of the underlying agreements in a court of law or, in
some cases, before an arbitrator.81 These legal opinions assure the parties that there are no
hidden issues that might create obstacles to enforcement. In addition, lawyers are
required by professional ethics to investigate compliance, disclosure, and due diligence
issues in order to understand their clients’ legal exposure when an innovative approach to
existing financial or commercial transactions is contemplated.82 Lawyers and accountants
themselves have direct exposure for documents submitted by a client to the Securities and
Exchange Commission under several laws, including the Sarbanes-Oxley Act of 2002.
A fundamental predicate of a lawyer’s opinion is the knowledge that the basic
transactional building blocks of the deal are well-known, predictable, and do not pose any
significant risk that a court will refuse to enforce them as intended by the parties. In
simple terms, this means that the deal is structured in a way that has certainty,
consistency, predictability, and transparency.83
79 See supra note 59 and accompanying text.
80 See VOGEL & HAYES, supra note 18, at 24-28. Vogel and Hayes note especially the minority
view that interest is not prohibited: “But such Muslims, though numerous, appear to be in the
minority. A much larger number, supported by a near-unanimity of traditional scholars, seem
certain that modern bank-interest falls within the revealed prohibitions and entails a major sin,
tolerable only in the throes of necessity.” Id. at 25 (emphasis added).
81 In some complicated cases, both judicial and arbitration venues are chosen depending upon the
specific issue litigated or the type of enforcement sought. See, e.g., McMillen, supra note 9.
82 See generally David S. Ruder, Lessons From Enron: Director and Lawyer Monitoring
Responsibilities, (Oct. 10, 2002) (paper presented to the 41st Annual Corporate Counsel Institute,
Chicago, Illinois), available at
http://www.law.northwestern.edu/professionaled/documents/Ruder_Lessons_Enron.pdf (last
visited Jan. 28, 2008); see also MODEL RULES OF PROF’L CONDUCT R. 1.2(d) (2002); AM. BAR
ASS’N, ANNOTATED MODEL RULES OF PROFESSIONAL CONDUCT 39-40 (5th ed. 2003).
83 While the terms “certainty, consistency, predictability, and transparency” are oft-used in the
law in this context, this memorandum borrows these precise terms and their meanings from one
of SCF’s biggest advocates and one of the most influential of the legal practitioners making a
2 0
The problems legal counsel face when attempting to analyze a specific SCF transaction
and to opine on compliance and enforceability issues are often related to the Shari’ah
“black box” phenomenon. Attorneys, accountants, and financial advisors who wish to
structure a transaction to be Shari’ah-compliant do so by treating Shari’ah precisely as
Shari’ah demands. For the Shari’ah faithful, Shari’ah is first and foremost the divine and
perfect will of the ultimate lawgiver and there are strictures and obligations imposed on
its adherents which are not subject to reasoned critique or discourse. As to the part of
Shari’ah open to human analysis, it is reserved for Shari’ah authorities who cannot be
challenged except by other equally authoritative Shari’ah authorities.84 Further, because
Shari’ah is understood as divine and the Shari’ah authorities are considered the trustees
of its authority, integrity, and interpretation, the application of Shari’ah’s wellestablished
and ancient doctrines to the modern practice of SCF necessarily lacks
transparency.
Shari’ah’s inability to provide transparency is systemic. Any legal or normative system
that is not articulated and enforced within a political structure of codified laws,
procedures, courts, binding legal opinions, and effective enforcement mechanisms will,
by definition, lack transparency. Shari’ah is at its core a divinely ordained law which can
never be subordinated to a secular political, legal, or regulatory system.85 SCF is an
attempt by the participants – financiers, businessmen, facilitators, and Shari’ah
authorities – to fit the divine law within a modern secular political, legal, and financial
system. But should a secular court or legislature attempt to codify Shari’ah’s precepts as
they apply to SCF in an effort to establish transparency, it would fail its fundamental
purpose because Shari’ah cannot be rendered subservient to secular law.86
career of SCF in Michael J.T. McMillen, Islamic Shari’ah-compliant Project Finance: Collateral
Security and Financing Structure Case Studies, 24 FORDHAM INT’L L.J. 1184 (2001).
84 As discussed supra at notes 60-62 and accompanying text, there is no universal standard of
authority or hierarchy for Shari’ah authorities. This fact alone and the development of
authoritativeness is part of the black box of Shari’ah.
85 See, e.g., McMillen, supra note 81, at 1196, n.14.
86 According to Shari’ah doctrine rooted directly and firmly in the Qur’an, and agreed upon by all
legal schools, no secular law can take precedence over Allah’s divine law: “Whoever does not
follow the revealed law and does not judge according to it is counted an unbeliever.” See, e.g.,
AL-AZAMI, supra note 29, at 12; see also Coughlin, supra note 24, at 90:
Known among Islamic jurists to take a more “liberal” view toward Islamic law,
Mohammad Hashim Kamali, in his Principles of Islamic Jurisprudence, nonetheless
comes down four-square on the notion of the absolute sovereignty of Allah that
necessarily pre-empts all other forms of sovereignty – including the democratic concept
of sovereignty of the people.
The blending of secular law and Shari’ah as it has unfolded in many Muslim countries would
appear to be ipso facto evidence of the failure to tame Shari’ah since there are no Muslim
dominated countries that one might call “mostly free” with real representative government except
possibly Turkey and Indonesia. Most observers recognize Turkey’s success has come at the
expense of “religious freedom” since the Kemalists and their use of the army to suppress the
public expression of Islam and Shari’ah is well documented. Indonesia is changing for the worse
due in large part to the growing violence against non-Muslims which in turn is due in large part to
2 1
In contrast, domestic finance and commerce in the U.S., and indeed international
financial transactions, are based upon Western legal structures that provide transparency.
It is transparency which renders a complex transaction manageable and viable. When the
parties to a transaction and the professionals facilitating it know that a given transaction
format has been used before successfully, the risks of the deal are then limited to the
specific business terms and market conditions rather than the formalities of the
documents and their enforcement. In these transactions, the lawyer can opine with
confidence because she knows the rules of the game and knows they are not subject to
fiat or challenge.87
This is not the case when a lawyer confronts a high-stakes, complex SCF transaction. In
order to render a legal opinion that will satisfy the parties and necessary third parties such
as a rating agency for a bond securitization, a number of issues arise that cannot be
rationally addressed for at least two reasons: Certain transaction restrictions applicable to
SCF are considered divine and unalterable; and those aspects of a transaction subject to
human reason are not subject to any human reason, but to the reason of a Shari’ah
authority. For example, interest income is understood by most Shari’ah authorities today
to be forbidden. The result has been that SCF utilizes all sorts of Shari’ah-compliant
transactional structures to convert the exact same income stream from interest to
something else, such as lease payments. In legal parlance, this is the application of “form
over substance”.88
the increasing influence of Shari’ah. See, e.g., Freedom House, Country Reports, available at
http://www.freedomhouse.org/template.cfm?page=21&year=2007 (last visited Jan. 28, 2008)
[hereinafter Freedom Survey 2007]. For a careful analysis of the extent to which Shari’ah is
codified as the law of the land in Muslim countries, see TAD STAHNKE & ROBERT C. BLITT, U.S.
COMM. ON INT’L RELIGIOUS FREEDOM, THE RELIGION-STATE RELATIONSHIP AND THE RIGHT TO
FREEDOM OF RELIGION OR BELIEF: A COMPARATIVE TEXTUAL ANALYSIS OF THE
CONSTITUTIONS OF PREDOMINANTLY MUSLIM COUNTRIES (Mar. 2005) [hereinafter STAHNKE &
BLITT, RELIGIOUS FREEDOM SHARI’AH REPORT], available at
http://www.uscirf.gov/countries/global/comparative_constitutions/03082005/Study0305.pdf (last
visited Jan. 28, 2008). For an examination of “religious freedom” in such Muslim countries as
Indonesia, Egypt, Iran, Saudi Arabia, see U.S. COMM. ON INT’L RELIGIOUS FREEDOM, ANNUAL
REPORT (May 2005), available at
http://www.uscirf.gov/countries/publications/currentreport/2005annualRpt.pdf#page=71 (last
visited Jan. 28, 2008). For the growing influence of Shari’ah in Indonesia, see Tom A. Peter, At
Massive Rally, Hizb Ut-Tahrir Calls For A Global Muslim State, CHRISTIAN SCIENCE MONITOR,
Aug. 14, 2007, available at http://www.csmonitor.com/2007/0813/p99s01-duts.html (last visited
Jan. 28, 2008). For a good discussion of “modernist legislation” vis-à-vis Shari’ah in Muslim
countries, albeit somewhat dated, see SCHACHT, supra note 62, at 100-111.
87 Certainty, consistency, predictability, and transparency in transactional law are never perfect
but operate within a range of comfort for investors. The market tends to step in and price deals
inversely to their approximation of these goals. As transparency goes down, price goes up until
the deal or product just is no longer in reach of the demand’s willingness to pay.
88 For a SCF-friendly practitioner’s view of these problems, see McMillen, supra note 81.
2 2
The use of legal fictions to change the form or the consequence of a transaction without
changing its substance is not new to secular law. Liability is often determined by the form
rather than the substance of a transaction.89 The idea is to use a legal fiction to convert a
problematical “form” to an acceptable one. In the secular context, the problem itself and
the mechanisms to overcome it can be understood, challenged openly, debated, and
ultimately modified by lawyers, judges, and legislatures to fit changing circumstances.
The debate within Shari’ah, however, is effectively closed. Its principles remain divine
and unalterable90 and the application of these principles to changing circumstances are
subject only to what the Shari’ah authorities acting independently of a secular legal and
political system determine to be permitted and forbidden. Thus, Shari’ah informs the
Shari’ah-adherent participants in a finance transaction that interest is divinely forbidden.
The participants are also told it is forbidden because it is evil and causes the destruction
of society.91 Somehow though, interest, wrapped up in a different form where all of the
elements of interest exist but the name, exits the black box of Shari’ah as permissible and
presumably good for society.92
Thus a lawyer involved in a complex SCF transaction confronts challenges at many
different levels. In this effort, the diligent lawyer would likely focus on four distinct
phases of an SCF transaction: (1) determining if the generic investment or type of
transaction is prohibited; (2) developing an alternative (i.e., Shari’ah-compliant)
transactional structure necessary to achieve the financial or commercial goal of the
“secular” or Shari’ah non-compliant investment or transaction; (3) drafting the necessary
89 The existence of the “corporate veil” to protect the individual from liability is a good example
of this “form” over “substance.” Even though an individual might “maintain the corporate
formalities,” in substance he is acting as the sole entrepreneur but the law and the policy behind
the law shield him from personal liability to promote the risk taking inherent in commercial
endeavors. For a discussion of this “legal fiction,” see Sanford A. Schane, The Corporation Is A
Person: The Language Of A Legal Fiction, 61 TUL. L. REV. 563 (1987).
90 Even this is not exactly true. According to some scholars, interest was once not divinely
prohibited per se. But the debate about the divinity of this prohibition as it exists today is not
open to a societal or political discussion and conclusion. Rather, it is confined to the Shari’ah
black box entrusted to the Shari’ah authorities. See generally KURAN, supra note 18; El-Gamal,
supra note 18.
91 See, e.g., Text of the Historic Judgment on Interest Given by the Supreme Court of Pakistan,
ALBALAGH, http://www.albalagh.net/Islamic_economics/riba_judgement.shtml (last visited Jan.
28, 2008).
92 Islamic scholars in academia have given this issue much attention. See, e.g., Mahmoud A. El-
Gamal, An Economic Explication of the Prohibitions of Riba in Classical Islamic Jurisprudence,
in THE PROCEEDINGS OF THE THIRD HARVARD UNIVERSITY FORUM ON ISLAMIC FINANCE:
LOCAL CHALLENGES, GLOBAL OPPORTUNITIES 29-40 available at
http://www.ruf.rice.edu/~elgamal/files/riba.pdf (last visited Jan. 28, 2008); see also KURAN,
supra note 18; McMillen, supra note 87, at [page number] n.2; Timur Kuran, The Genesis Of
Islamic Economics; A Chapter In The Politics Of Muslim Identity, Social Research (Summer
1997), available at http://findarticles.com/p/articles/mi_m2267/is_n2_v64/ai_19652892/pg_1
(last visited Feb. 1, 2008).
2 3
legal agreements and documents to implement the alternative transaction; and (4)
preparing the filing of regulatory documents with government agencies.
At each stage, the lawyer is in effect wrapping the Shari’ah component of SCF in what
appears to be a secular black box. By doing so, the lawyer exposes herself and her client
to substantial civil and criminal liability. Part III.B below discusses various areas of legal
risk, and Part III.C suggests an analytical taxonomy for evaluating these risks in the SCF
context.
B. The legal landscape
1. Common law tort action for deceit or fraud
The regulation of disclosures by businesses, and by the financial industry in particular,
has a long and storied history in U.S. jurisprudence. In most states, the common law
incorporated the tort action of deceit, commonly referred to as fraud, to allow private
rights of action for misrepresentation in the context of what is now referred to as
commercial speech.93 The essential elements of a common law fraud action are: (1) a
false representation (2) of a material fact (3) which the defendant knew to be false and (4)
with the intent to induce the plaintiff to rely upon it and (5) the plaintiff in fact justifiably
relied upon the representation (6) thereby suffering damages as a result.94
Most states have relaxed or altered many of the elements of common law fraud. For
example, certain relationships under the common law might also give rise to a claim for
constructive fraud, which allows recovery for an omission of material fact. The scienter
elements have also been relaxed. Thus, the intent elements noted above in (3) and (4),
have been “variously defined to mean everything from knowing falsity with an
implication of mens rea, through various gradations of recklessness, down to such
nonaction as is virtually equivalent to negligence or even liability without fault (and
would be better treated as creating a distinct species of liability not based on intent).”95
2. Federal securities laws
In addition to common law actions for fraud or misrepresentation, there are federal and
state statutory regimes designed to govern disclosures in a myriad of business and
financial contexts, including the sale of goods and the provision of loans; investments
such as the formation of partnerships; and the sale of intangibles such as the offering of
securities. In the world of SCF, the disclosure statutes most obviously implicated in civil
and criminal liability issues are the federal and state securities laws.
93 See Nike, Inc. v. Kasky, 539 U.S. 654 (2003) (per curiam) (Stevens, J., concurring) (discussing
commercial versus non-commercial speech and suggesting that case was disposed of summarily
on procedural grounds).
94 LOSS & SELIGMAN, supra note 5, at 910.
95 Id. at 911.
2 4
In the main, the securities laws relating to fraud and misrepresentation were modeled
after common law fraud. But it is equally true that Congress intended the securities fraud
statutes to have a broader reach than the common law. As a result, securities law sought
to include within its enforcement orbit misrepresentations, omissions, schemes, and
artifices that would not otherwise be captured by traditional common law fraud. In
addition, many of the specific elements of common law fraud were relaxed or in some
cases eliminated. While recent federal legislation aimed at curbing abusive class action
litigation and subsequent Supreme Court caselaw suggest a trimming of the broad reach
previously granted federal securities laws, this is counterbalanced by a concomitant
movement at the state level to extend the reach of the state securities laws and to interpret
them more liberally than the federal counterparts.96
There are principally seven federal statutes that govern securities transactions: the
Securities Act of 1933; the Securities Act of 1934; the Trust Indenture Act of 1939; the
Investment Company Act of 1940; the Investment Advisors Act of 1940; the Securities
Investor Protection Act of 1970; and the Sarbanes-Oxley Act of 2002.97 Civil and
criminal liability under the federal securities statutes for failure to disclose is regulated by
the SEC and its principal weapons are the Securities Act of 1933 ("1933 Act") and the
Securities Exchange Act of 1934 ("1934 Act").98 The 1933 and 1934 Acts target different
markets. The 1933 Act regulates initial offerings and the 1934 Act regulates all
subsequent trading, but the overriding public policy is the same: “full disclosure of every
essentially important element attending the issue of a new security” and a “demand that
96 Id. at 1187-1192.
97 Securities Act of 1933 (Truth in Securities Act), 15 U.S.C. §§ 77a to 77aa (2006) (focuses on
initial distribution of securities); Securities Exchange Act of 1934, 15 U.S.C. §§ 78a to 78mm
(focuses on ongoing post-distribution trading of trading); Trust Indenture Act of 1939, 15 U.S.C.
§§ 77aaa to 77bbbb (supplements the 1933 Act and focuses on distribution of debt securities);
Investment Company Act of 1940, 15 U.S.C. §§ 80a-1 to 80a-64 (governs activity of publicly
owned companies that invest in and trade securities); Investment Advisers Act of 1940, 15 U.S.C.
§§ 80b-1 to 80b-21 (requires regulation and registration of those in business of advising others on
securities investments); Securities Investor Protection Act of 1970, 15 U.S.C. §§ 78aaa to 78111
(creates nonprofit membership corporation designed to cover customer losses when broker-dealer
firms cannot cover their customer accounts); Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204,
116 Stat. 745 (codified as amended in scattered sections of 11, 15, 18, 28, and 29 U.S.C.) (adds
several additional lawyers of corporate reporting and ethics oversight). The Public Utility
Holding Company Act of 1935, 15 U.S.C. §§ 79 to 79z-6, which governed public utilities, was
repealed by the Energy Policy Act of 2005, Pub. L. No. 109-58, 119 Stat. 594.
98 No analysis of the current SCF industry in the U.S. would be complete without an examination
of the Investment Company Act of 1940 and the Investment Advisors Act of 1940. This is
because much of the SCF investments are being propelled by mutual funds tracking the DJII and
the S&P’s version of the same thing. In addition, with the huge sovereign wealth in the GCC
looking for sophisticated investment strategies, Shari’ah compliant hedge funds are right around
the corner. The analysis which follows will examine these two acts to the extent they implicate
these types of SCF investments and require a different analysis of the liability exposure for
securities fraud.
2 5
persons, whether they be directors, experts, or underwriters, who sponsor the investment
of other people’s money should be held to the high standards of trusteeship.”99
Although both the 1933 and the 1934 Acts proscribe various types of conduct, including
incomplete or inaccurate disclosure of material information, as an administrative matter
the SEC dictates the specific kinds of minimal (and in some cases maximal) disclosure
required by the specific provisions. Beyond the routine administrative functions granted
the SEC, the main weapons against securities fraud are the civil and criminal remedies.
Thus, the SEC has access to civil courts to seek injunctive relief, disgorgement, and even
civil fines, in addition to ancillary equity-like relief. In addition, the Department of
Justice, often as a result of an SEC administrative investigation and criminal referral, is
authorized to file criminal charges for violations of the federal securities laws when it
appears the offending party had the requisite intent.100 Finally, private plaintiffs have
express and implied rights of action under several provisions. The most used and abused
of all such provisions is Rule 10b-5101, promulgated under the 1934 Act102, which
provides for civil litigation103 and criminal prosecutions.104 Considering that the class
action mechanism, although limited by recent legislation105, is available to Rule 10b-5
claimants, the weapons available to prosecute claims for misstatements and omissions of
material fact in SEC filings and elsewhere in the public domain are considerable.
3. State securities laws
State securities laws, usually referred to as blue sky laws, essentially track the
development of securities disclosure law and securities fraud liability in federal securities
law. As noted above, as a result of Congress’ efforts to curb private securities fraud
litigation and recent Supreme Court rulings regarding the new pleadings requirements,
the state securities laws will take on ever greater importance in the securities plaintiff’s
arsenal of litigation weapons.106
4. Federal and State consumer protection and anti-fraud laws
99 H.R. REP. NO. 73-85, at 3 (1933); see 1934 Act, 15 U.S.C. § 78b (stating that one purpose of
securities law is “to insure the maintenance of fair and honest markets”).
100 See generally LOSS & SELIGMAN, supra note 5, at Chapter 9-B-6.
101 17 C.F.R. § 240.10b-5 (1997); see Herman & Maclean v. Huddleston, 459 U.S. 375, 380
(1983) (“The existence of this implied remedy is simply beyond peradventure.”).
102 15 U.S.C. § 78j.
103 See generally LOSS & SELIGMAN, supra note 5, at 910, 1273-1301 (implied right of action
under Rule 10(b)-5).
104 15. U.S.C. § 78ff(a) (criminal penalties); see LOSS & SELIGMAN, supra note 5, at 1418-1425.
For a general survey of criminal liability under the securities acts, see Nic Heuer, Les Reese &
Winston Sale, Securities Fraud, 44 AM. CRIM. L. REV. 956 (2007).
105 See Jeffrey T. Cook, Recrafting The Jurisdictional Framework For Private Rights Of Action
Under The Federal Securities Laws, 55 AM. U.L. REV. 621 (2006).
106 Supra note 93.
2 6
Consumer protection statutes, which exist in most states, provide additional weapons to
combat fraud. While the Federal Trade Commission Act (“FTC Act”)107 does not apply to
securities, it might be implicated where businesses market consumer products and
represent that their businesses are run according to Shari’ah. Further, modeled in part
after the FTC Act, the “little FTC Acts” enacted by most states are often more broadly
interpreted than the FTC Act and many have an express or implied private right of action
allowing the consumers themselves to battle fraud in the marketplace.108
In California, for example, a private plaintiff sued Nike, Inc., an Oregon corporation, on
behalf of all California residents under the California Unfair Competition Law109 for
fraud and failure to disclose. The suit was filed after Nike had made false and misleading
public statements in the wake of media reports suggesting abuse at its foreign factories.
Nike claimed its speech was protected under the First Amendment. The case went to the
U.S. Supreme Court after Nike’s arguments to get the case dismissed on First
Amendment grounds did not persuade the California Supreme Court. But the U.S.
Supreme Court sent it back down to the California courts after it determined that
certiorari had been improvidently granted.110 Nike settled the case.111 The implications of
this type of state action for the SCF industry will be addressed below. Also, at least three
states allow their respective consumer protection statutes to be used for securities fraud,
which would bring the entire SCF industry under consumer fraud scrutiny.112
Additional statutes implicated are the federal Lanham Act, which regulates inter alia
fraud in the description of goods, services, or commercial activities,113 and laws
governing consumer finance. Consumer finance in the U.S. falls within the ambit of the
federal Truth-in-Lending Act (“TILA”)114 and the myriad of regulations promulgated
thereunder referred to collectively as Regulation Z.115 Banks and other lenders
107 15 U.S.C. §§ 41-58.
108 For a discussion of the broad sweep of state consumer fraud statutes, see Victor E. Schwartz &
Cary Silverman, Common-Sense Construction of Consumer Protection Acts, 54 KAN. L. REV. 1
(2005).
109 The law, known as the Unfair Competition Law (“UCL”), is codified at CAL. BUS. & PROF.
CODE §§ 17200-17210 (Deering 2007).
110 Supra note 93. The UCL recently was amended by Proposition 64 to eliminate the right of
private plaintiffs to sue as “private attorneys general” without a showing of injury. See Schwartz
& Silverman, supra note 108, at 34-37.
111 David Monsma & John Buckley, Eighteenth Annual Corporate Law Symposium: Corporate
Social Responsibility In The International Context: Is There An Emerging Fiduciary Duty To
Consider Human Rights?, 74 U. CIN. L. REV. 75 (2005).
112 For Pennsylvania, see Denison v. Kelly, 759 F. Supp. 199, 202 (D. Pa. 1991) (referencing 73
PA. CONS. STAT. §§ 201-1-202-9.3 (2007)). For Illinois, see Onesti v. Thomson McKinnon
Secur., Inc., 619 F. Supp. 1262, 1267 (D. Ill. 1985) (referencing ILL. REV. STAT. ch. 121 1/2, §
262, et seq. (1985), now 815 ILL. COMP. STAT. 505/2 (2007)). For Arizona, see State ex rel.
Corbin v. Pickrell, 136 Ariz. 589, 592 (Ariz. 1983) (referencing ARIZ. REV. STAT. ANN. §§ 44-
1522 – 1531 (2007)).
113 15 U.S.C § 1125 (2006).
114 15 U.S.C. §§ 1601-1693r.
115 15 U.S.C. app. 12 CFR § 226.
2 7
advertising “zero interest loans” or “riba free loans” might in fact run afoul of the TILA
disclosure requirements and the restrictions on deceptive advertising. The Home
Ownership and Equity Protection Act (“HOEPA”)116, which is part of TILA, or the state
versions of HOEPA might also apply to what amounts to predatory lending to Shari’ahadherent
Muslims to the extent that the fees and costs are almost always higher than
conventional loans.
5. Due diligence and compliance statutes
The federal securities laws in several instances incorporate due diligence as defenses to
the anti-fraud provisions and as such are an integral part of any legal analysis for civil or
criminal exposure.117 In addition, due diligence is incorporated into several compliance
regimes such as the Bank Secrecy Act118 and the anti-money laundering statutes119, many
of which were modified by the Patriot Act. Insofar as SCF incorporates the Shari’ah
obligation to tithe and also requires the “purification” of profits earned in violation of
Shari’ah, the question for the legal practitioner is who decides what happens to the
monies gifted to charities and which charities are selected. Given the historical
connection between some of the largest and well-known Muslim charities and the
funding of terrorist groups120, these questions take on added focus in the context of
material support of terrorism. Finally, the structure of the Shari’ah authority boards and
their professional membership organizations raise antitrust issues.
C. A Suggested Analytical Taxonomy
The challenges described above for the SCF transactional lawyer and other professionals
advising clients on the intricacies of legal compliance are not inconsequential. In
agreements and in law, words are given context by the intent of the parties. The inherent
problem of SCF is that the intent of the parties is to comply with Shari’ah but the intent
of Shari’ah generally and in any particular transaction is typically lost on the secular SCF
advisors.121 The latter, especially the lawyers, are very good at solving problems by restructuring
a transaction through wordsmithing, thereby arriving at the same result in
different form. But their approach is to deal only with the trees hindering the client’s path
to the goal within the landscape of the transaction itself.
116 Pub. L. No. 103-325, 108 Stat. 2190 (codified as amended in scattered sections of 15 U.S.C.).
117 LOSS & SELIGMAN, supra note 5, at 1205 (defense of reasonable care under Section 12(a)(2)
of the 1933 Act); id. at 1227-1239 (reasonable care and “expertizing” defenses under Section 11
of the 1933 Act).
118 31 U.S.C. §§ 5311-5332 (2006).
119 See infra Part V.C.1.a.
120 See infra Part V.C.1.b.
121 It is not enough to refute this proposition by stating that the intent of Shari’ah is known: the
avoidance of interest, speculation, and vice. If the refutation were both true and meaningful, it
would suggest that the speaker knows what Shari’ah means by interest, speculation, and vice.
And, if that were true, the speaker could devise his own legal structures without reference to or
assistance from Shari’ah scholars and authorities. But this is not the case.
2 8
For the typical secular financial transaction, this is sufficient because there is no dark
forest in which to get lost. An obstacle in the path can be safely circumvented because the
problem is transparent and thus its ramifications for disclosure and compliance are
understood. When the trees, however, grow out of the forest known as Shari’ah, it is not
at all clear to these professionals why they are where they are, what dangers might lurk
there, and where the forest might lead. This is because Shari’ah is not accessible to the
secular professionals. As a consequence, the forest is packaged as a black box and
ignored. It is no surprise then that professional literature has paid little attention to the
liability and criminal exposure issues unique to a financial or business transaction fitted
to Shari’ah.122
This Article seeks to facilitate academic and professional scrutiny of SCF by suggesting
an analytical taxonomy separating SCF-related legal exposure in to two elements: that
arising of out endogenous elements, and that arising out of exogenous elements.
1. Exposure arising out of endogenous elements
To understand the risks and exposure for a financial institution contemplating SCF, a
lawyer must first understand what Shari’ah itself says it is – that is, what the Shari’ah
authorities understand it to be, without reference to how SCF attempts to navigate the
demands of modern finance. This inquiry can be termed an analysis of the endogenous
elements or aspects of Shari’ah123, and it will be relevant to many fundamental issues of
SCF. Moreover, to the extent that Shari’ah compliance is determined by Shari’ah
authorities, presumably there is something in the institution of Shari’ah itself that will
inform a lawyer who qualifies for such a role and how. Finally, to the extent that Shari’ah
122 A good example is to look at the published works of the legal practitioners making a living
providing expert legal services to the SCF industry. The articles by McMillen cited herein
generally are examples but notably see McMillen, supra note 81, at [page number] n.18 and
accompanying text where the author waxes on about the utilization of Shari’ah in Saudi Arabia
and various other Muslim countries and does not raise even a word of caution regarding the
abuses well documented under the Shari’ah legal system.
123 Borrowed term from ENCYCLOPEDIA OF SOCIAL SCIENCE RESEARCH 308-309 (Michael
Lewis-Beck, Alan Bryman & Tim Futing Liao eds., 2003), available at http://wwwpersonal.
umd.umich.edu/~delittle/Encyclopedia%20entries/endogeneous%20variable.pdf (last
visited Jan. 28, 2008). The endogenous/exogenous taxonomy for analyzing disclosure has an
ancient pedigree. In standard common law fraud, commentators such as Judge Story distinguished
between the heightened duty to disclose for intrinsic elements of a deal versus the extrinsic:
Intrinsic circumstances are properly those which belong to the nature, character,
condition, title, safety, use, or enjoyment, &c., of the subject-matter of the contract, such
as natural or artificial defects in the subject-matter. Extrinsic circumstances are properly
those which are accidentally connected with it, or rather bear upon it at the time of the
contract, and may enhance or diminish its value or price, or operate as a motive to make
or decline the contract; such as facts respecting the occurrence of peace or war, the rise or
fall of markets, the character of the neighborhood, the increase or diminution of duties, or
the like circumstances.
1 JOSEPH STORY, COMMENTARIES ON EQUITY JURISPRUDENCE 300, at 301-02 (W. H. Lyon, Jr.
ed., Little, Brown & Co. 14th ed. 1918) (1834).
2 9
is in fact what its proponents say it is – a way of life combining authoritative Islamic
legal, moral, theological, and normative social constructs – an attorney has a
responsibility to ensure that her client has conducted the necessary due diligence to be
certain that these structures do not violate U.S. law. Part IV below explores these
endogenous elements in further detail.
2. Exposure arising out of exogenous elements
As discussed above, SCF is a term of art used to describe the contemporary Islamic
response to the demands of modern finance and commerce. As such, the rules and norms
of Shari’ah are being forced to attend to the demands of a Muslim demographic which
desires to exploit the opportunities available in Western financial and legal structures yet
at the same time to remain faithful to a system which rejects as unlawful and evil much of
the Western financial premises about political economies and structures. To achieve this
seemingly impossible goal, Shari’ah authorities have developed a range of transactional
structures and legal-definitional parameters to guide them in their determination whether
a given transaction or investment is permitted or prohibited.
In this part of the analysis, a lawyer should address the features of SCF that might raise
liability exposure issues that are not inherent to Shari’ah principles but are adaptations of
Shari’ah principles to fit Western financial structures and institutions. An example of a
transactional structure to deal with this collision between a Shari’ah world and a Western
one built on the time-value of money is the sale-lease back agreement.124 While sale-lease
back agreements are not unique to SCF and in fact are a popular vehicle in contemporary
finance, in the two contexts they are not identical in structure and worlds apart in their
purposes.125 An example of the legal-definitional parameters set out by Shari’ah
authorities to deal with the doctrinal conflicts between the two systems would be the
ruling that, while interest income is absolutely forbidden in Shari’ah, it is not forbidden
to invest in a company that earns less than X%126 from interest income which is not a
124 One such Shari’ah-based nominate lease contract is called Ijara. VOGEL & HAYES, supra note
18, at 143-145.
125 Typically, a sale-lease back financing transaction is a way for a company to gain liquidity and
to move a capital asset off the balance sheet to avoid the burdens to the company’s debt ratios if
standard capital asset financing is used. For a short discussion of the accounting aspects, see
Richard J. Strotman, Sale/leaseback: Financing Tool for the ‘90s, CPA J. ONLINE (Apr. 1991),
available at http://www.nysscpa.org/cpajournal/old/10691657.htm (last visited Jan. 28, 2008).
The motivation for a Shari’ah sale-lease back, however, is to avoid interest and to accommodate
Shari’ah fixed rules relative to the actual transfer of ownership of the property, who is
responsible for repairs (lessor), who can cancel the contract under changed circumstances
(lessee), and how the parties will treat future sale and option terms. In other words, the purposes
of a secular sale-lease back are purely for accounting purposes or “form”; for the Shari’ah
contract, however, the purpose is to effect the actual form required by Shari’ah as “substance”.
126 See Yaquby, supra note 38 (various Shari’ah authorities prohibit investment in companies that
earn more than 5-15% of total earnings from interest income). The DJII achieves this prohibitory
goal by screening out companies with a debt to market capitalization equal to or greater than
33%. For this and other ratios intended to screen for interest income, see M. H. Khatkhatay &
Shariq Nisar, Investment in Stocks: A Critical Review of Dow Jones Shari’ah Screening Norms,
3 0
core business of the company (i.e., interest earned on liquid assets or accounts
receivables). Further discussion of the exogenous elements of SCF is provided in Part V
below.
IV. The Endogenous Elements: Disclosure of Shari’ah in SCF
A. The preliminary analysis
The first order of business for an attorney providing advice in the context of disclosure
laws to a U.S. financial institution interested in SCF should be answering the following
question: How intimate is the connection between SCF and Shari’ah itself? (In legal
terms, how material is Shari’ah to SCF?) If Shari’ah is a material part of SCF, the
attorney must confront the likelihood that it is a material fact of SCF in the context of
disclosure laws. While the answer to the question might appear self evident – that is,
Shari’ah has everything to do with SCF – extant literature by legal scholars and
practitioners suggests that, even if Shari’ah is a material component of SCF, it is not
material to any of the disclosure laws because Shari’ah is treated as a black box that
merely turns out rules requiring specific kinds of contractual arrangements.
But secular lawyers’ treatment of Shari’ah as a black box that does not concern them,
except in the specific rulings relative to a given investment or transaction, is simply a
willful avoidance of material facts. Those facts are the endogenous elements of Shari’ah
that result in the “rules and principles” of SCF.127 Indeed, according to the proponents
and practitioners of SCF, Shari’ah is not just an approach to interest-free, ethical Islamic
business practices or investing. Invariably, SCF is described by its proponents,
practitioners, and scholars as the contemporary Islamic legal, normative, and communal
response to the demands of modern day finance and commerce. What makes the response
“Islamic” or one pursued almost exclusively by Muslims128 is the fact that this legal,
normative, and communal response to modern finance is framed and regulated by
Shari’ah authorities ruling on what Shari’ah permits and prohibits. Thus, whether called
Shari’ah-compliant finance, Islamic economics and finance, or even “ethical” investing,
the one unifying characteristic of SCF is the appearance of authoritative Muslim Shari’ah
scholars who, individually and collectively through various manifestations of
Paper Presented at the Int’l Conference on Islamic Capital Markets (Aug. 27-29, 2007), available
at
http://www.djindexes.com/mdsidx/downloads/Islamic/articles/DowJonesShariahScreeningNorms
.pdf (last visited Jan. 28, 2008).
127 “Shari’ah rules and principles” is a term of art among Shari’ah authorities. Various standards
publications are available to the public through the Islamic Financial Services Board (“IFSB”),
one of the premier standards institutes of SCF. See IFSB Published Standards, Islamic Financial
Services Board,, http://www.ifsb.org/index.php?ch=4&pg=140 (last visited Jan. 28, 2008)
[hereinafter IFSB Standards].
128 Excepting of course the non-Muslim facilitators and financial institutions who desire to exploit
it for purely pecuniary gain.
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consensus129, define the “rules and principles” of SCF and set out how a Shari’ahadherent
Muslim may “lawfully” engage in commerce, investing, and finance.
Further, the Shari’ah authorities are clear: SCF is not a discreet or segregable component
of Shari’ah. It is a fully integrated discipline within the corpus juris of Shari’ah which, in
turn, is a holistic, all-encompassing way of life. Shari’ah is not divisible, moreover, in the
sense that one might extract the SCF “commercial legal code” from Shari’ah and end up
with a body of laws articulating a secular code of business conduct. This is demonstrated
by the prohibitions against businesses that trade in pork products (seemingly a strictly
dietary code issue) or the leasing of a building to a church (quite obviously a theological
consideration informing a business law issue).130 Even in the legal rulings relating to
whether a Muslim bank or individual may receive interest from deposit accounts, the
decision turns in large part on whether the deposits reside in a jurisdiction called the
“abode of war”, where non-Muslims predominate, or the “abode of peace”, where
Muslims predominate.131
The inclusiveness, universality, and indivisibility of Shari’ah are not just evidenced by
the published work of Shari’ah authorities on the one hand and secular academic scholars
on the other. Especially important for a lawyer attempting to determine what the
“Shari’ah” of SCF is in the context of disclosure laws, and what if anything of this
“Shari’ah” is material and subject to the duty to disclose, is what Shari’ah actually is in
practice. An attorney in search of the actual presentation of Shari’ah as an extant and
authoritative basis for law in modern times has the opportunity to examine several
Muslim regimes which have implemented Shari’ah as the law of the land. The best
examples of such implementation are Iran, Saudi Arabia, and Sudan.132 The Taliban of
Afghanistan had also imposed a fully authoritative Shari’ah and many other Muslim
regimes have utilized aspects of Shari’ah to complement a non-Shari’ah secular code.
The more a country’s laws are based upon Shari’ah, the better the evidence of what
Shari’ah is in actual practice devoid of all the academic theorizing and parsing.133
129 As the literature makes clear, consensus among Shari’ah authorities is an important part of the
tradition and integrity of Shari’ah. In some Muslim countries, however, there is actual
government oversight and regulation. See, e.g., THE POLITICS OF ISLAMIC FINANCE, supra note
10; see also Islamic Financial Services Board, Guidance on Key Elements of the Supervisory
Review Process of Institutions Offering Islamic Financial Services (Excluding Islamic Insurance
(Takaful) Institutions and Islamic Mutual Funds), at ¶¶ 110-118 at 24-25 (Dec. 2007), available
at
http://www.ifsb.org/view.php?ch=4&pg=257&ac=36&fname=file&dbIndex=0&ex=1201533270
&md=%C1h%D5%BB%AA%B9zc%C3%9E%7CV%29%0A%BA%3C (last visited Jan. 28,
2008) [hereinafter IFSB Standard].
130 Supra note 58 and accompanying text.
131 Supra note 59 and accompanying text.
132 See, e.g., STAHNKE & BLITT, RELIGIOUS FREEDOM SHARI’AH REPORT, supra note 86.
Recently, northern Nigeria has been added to this list. See Nigeria Turns From Harsher Side of
Islamic Law, N.Y. TIMES, Dec. 1, 2007, available at
http://www.nytimes.com/2007/12/01/world/africa/01shariah.html?_r=1&oref=login (last visited
Jan. 28, 2008).
133 Supra note 129; see Freedom Survey 2007, supra note 86.
Formatted: Font: 11 pt
Formatted: Font: 11 pt
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It is beyond this Article’s scope to determine what Shari’ah is in fact or what it means to
the contemporary Shari’ah authorities sitting as the final arbiters of SCF. Examining the
literature of Shari’ah over the course of its history, determining what Shari’ah is in
Muslim countries that apply traditional Shari’ah rules and principles and, importantly,
studying the published rulings by contemporary Shari’ah authorities on what Shari’ah
is134, what its purposes are, and what Shari’ah considers the appropriate means to achieve
those ends, are, however, all part of any inquiry into the material endogenous elements of
Shari’ah subject to disclosure.
B. The hypothetical: not so hypothetical
Notwithstanding a reluctance based on practical considerations to engage in a full
analysis of the material endogenous elements of Shari’ah, in order to provide a factual
predicate for the analysis of the disclosure (and other) laws that follow it will be helpful
to assume a fact or two about Shari’ah. Therefore, by way of example and for purposes
of the analysis, this Article assumes that, after a good faith investigation, a lawyer
advising a financial institution desiring to enter the SCF industry will determine that there
is a reasonable basis to conclude that a consensus exists among Shari’ah authorities on
the fundamental purpose and methodologies of Shari’ah: submission. Shari’ah seeks to
establish that Allah is the divine lawgiver and that no other law may properly exist but
Allah’s law. Shari’ah seeks to achieve this goal through persuasion and other non-violent
means. But when necessary and under certain prescribed circumstances the use of force
and even full-scale war to achieve the dominance of Shari’ah worldwide is not only
permissible, but obligatory.
While this memorandum poses these conclusions as a hypothetical, they are hardly
conjectural. In fact, they reflect the rulings of the classical Shari’ah authorities dating
back almost a millennium and include the most contemporary of Shari’ah authorities
issuing authoritative legal rulings today. This can be seen in an unpublished study of
Shari’ah and its foundational role as controlling doctrine for Shari’ah-ahderent terrorists
in their holy war against the infidel.135 This study, conducted by Major Stephen Collins
Coughlin, examines Shari’ah as law as it is defined and interpreted by Shari’ah
authorities themselves. Further, it surveys the binding rulings of Shari’ah authorities
from the classical periods dating back to the early days after Mohammed’s death,
including also the so-called Golden Era of Islamic enlightenment, through the chaotic
period around the fall of the Ottoman Empire, right through to the present. The
contemporary survey also includes a best-selling 7th grade textbook used in Islamic day
schools throughout the U.S. to validate the study’s choice of authorities and to confirm
that their legal rulings are used pedagogically as the foundation for understanding
traditional, Shari’ah-centered Islam.136 Further, Coughlin carefully authenticates the
134 An integral part of this inquiry is a study of the extant rulings of the classical Shari’ah
authorities considered to be authoritative by contemporary Shari’ah authorities.
135 Coughlin, supra note 24.
136 YAHIYA EMERICK, WHAT ISLAM IS ALL ABOUT: A STUDENT TEXTBOOK (GRADES 7 TO 12)
(5th
3 3
authorities so that one is not misled into accepting either a weak authority or an
“extremist” view point. The work is the best of any such scholarship because it treats
doctrinal Shari’ah as Shari’ah expects to be treated and as evidenced by the published
rulings of the Shari’ah authorities: as a sectarian legal-political-military normative social
construct sourced in divine and immutable law.
Coughlin’s study demonstrates that Shari’ah and the doctrines of war articulated as the
Law of Jihad are as valid today as they were one thousand years ago. Jihad should be
implemented as circumstances permit, and the contemporary authoritative Shari’ah
scholars continue to teach, preach, and issue legal rulings to this effect. Coughlin’s
investigation further explicates that, once the Shari’ah authorities reach a consensus on a
legal ruling based on the Qur’an and Hadith, that ruling is considered immutable and
irrevocable.137 This adds yet further concretization to the rulings on Jihad because the
purpose of Islam and the methodologies to achieve those ends per Shari’ah are
universally accepted by the Shari’ah authorities with but relatively minor exceptions as to
specifics.138
Based upon a consensus of legal authorities, this study places the Law of Jihad in a
milieu permeated by the consequences of the jurisprudential rule of consensus and
establishes three fundamental points:
[1] The goal of Jihad to convert or conquer the entire world and the
methodology to achieve this end by persuasion, by force and subjugation,
or by murder is extant doctrine and valid law by virtue of a universal
consensus among the authoritative Shari’ah scholars throughout Islamic
history.
[2] The doctrine of Jihad is foundational because it is based upon explicit
verses in the Qur’an and the most authentic of canonical Sunna, and it is
considered a cornerstone of justice: until the infidels and polytheists are
converted, subjugated, or murdered, their mischief and domination will
continue to harm the Muslim nation. And,
[3] Jihad is conducted primarily through kinetic warfare but it includes
other modalities such as propaganda and psychological warfare.
rev. ed. 2004).
137 Coughlin, supra note 24, at 97-108, 134 et seq.
138 One poignant example is Coughlin’s use of Averroes (aka Abu al-Walid Muhammad Ibn
Muhammad Ibn Rusd), one of the leading Shari’ah authorities of the so-called Golden Era in
Islamic history often touted as an age of Muslim enlightenment, pluralism, and peace. What
Coughlin points out, based upon available English translations of Averroes’ major work on Jihad,
is that even in their best light, Shari’ah authorities consistently maintain that infidels and
polytheists “must be fought.” See, e.g., Coughlin, supra note 24, at 184. For the entire work on
Jihad translated, see RUDOPH PETERS, JIHAD IN CLASSICAL AND MODERN ISLAM 27-42 (2005).
3 4
Coughlin’s thesis is supported by the rulings of at least one prominent contempory
Shari’ah authority. In a recent book, Mufti M. Taqi Usmani---a member of numerous
Shari’ah advisory boards and one of the most respected Shari’ah authorities in the world-
--advocates violent and aggressive Jihad even against peaceful non-Muslims if they don’t
heed the call to Islam.139 He bases his ruling explicitly on legal verses in the Qur’an, the
actions of Mohammed and the successor Caliphates, and a consensus among Shari’ah
authorities. If Coughlin is correct, then Usmani is but one example of a Shari’ah
authority who both embraces the Law of Jihad as an extant doctrine for action by
Shari’ah-adherent Muslims and bases his rulings on the classical Shari’ah authorities
who fully embraced the consensus on the Law of Jihad.
C. Applying the endogenous elements of Shari’ah to the specific duty to
disclose
As noted previously, the SCF industry in the U.S. includes a panoply of businesses
regulated by the securities laws. Mutual funds tracking one of the Islamic indexes,
publicly traded bond issuances and the trading of securitized bond issuances on a
secondary market, and even U.S. public companies announcing their commitment to
conducting their business according to the principles of Shari’ah are some of the more
obvious examples. Do the facts of Shari’ah – representing the overriding purposes of
Shari’ah and the methods authorized to achieve those purposes – require disclosure under
the securities laws?
Failure to disclose a material fact (or the material misrepresentation of an asserted fact) is
the basis for administrative, civil, and criminal actions under all of the securities laws
requiring disclosure. The breach of this duty might arise in a registration, prospectus or
other required filing with the SEC or “in connection with” a purchase or sale of
securities. For example, the 1933 Act imposes a number of requirements upon issuers,
underwriters, and dealers to make full and fair disclosures in securities offerings.140
Section 11 of the 1933 Act (“Section 11”) provides that purchasers of securities may sue
for material misrepresentations or omissions in registration statements as long as they did
not know of the misrepresentation or omission at the time of purchase.141 The dragnet
under Section 11 for potential defendants is fairly wide and includes: (1) any person who
signed the registration statement; (2) any person who was a director or partner of the
issuer at the time of the filing of the registration statement; (3) any person listed in the
registration statement as a soon-to-be director or partner; (4) every accountant, engineer,
appraiser, or other expert named in the statement after having consented, but only as to
any liability arising from the portion of the statement attributed to the specific expert; or
(5) any underwriter of the securities.142 In addition, Section 12 of the 1933 Act (“Section
12”) authorizes a purchaser of securities to sue the offeror or seller for any material
139 MUFTI M. TAQI USMANI, ISLAM AND MODERNISM 123-39 (2006).
140 See, e.g., 15 U.S.C. 77g (2006) (disclosures required in registration statements); § 77j
(disclosures required in prospectuses); § 77aa (schedules of information required in registration
statements).
141 Id. § 77k.
142 Respectively (1) § 77f; (2) § 77k(a)(2); (3) § 77k(a)(3); (4) § 77k(a)(4); and (5) § 77k(a)(5).
3 5
misrepresentation or omission in a prospectus and adds “oral communications” to the
landscape.143 The depth of the exposure from both of these provisions is the fact that a
private plaintiff need not allege or show actual reliance on the misrepresentation or show
that the absence of the material omission was in fact a contributing element.144
The preeminent statutory authority regarding disclosure in securities transactions is
Section 10(b) of the 1934 Act and its regulatory offspring Rule 10b-5. It has been the
source for much litigation due to its breadth and the fact that it includes an implied
private right of action, thereby adding private plaintiff and class action claims to the
enforcement suits by the SEC and DOJ criminal prosecutions.145 The essential elements
of a Rule 10b-5 action are:
(1) a misstatement or omission; (2) of material fact; (3) with scienter; (4) in connection
with the purchase or the sale of a security; (5) upon which the plaintiff reasonably relied;
and (6) that the plaintiff's reliance was the proximate cause of his or her injury. 146
Once these elements of the Rule 10b-5 cause of action are established, a criminal penalty
can be imposed under section 32(a) if the government satisfactorily proves a willful
violation of the 1934 Act.147
This Article examines two unique elements to most fraud claims based upon allegations
that the defendant omitted material information about Shari’ah in public filings and
representations: materiality and scienter. Because the discussion regarding materiality in
a federal securities fraud action also applies to fraud claims under the common law, state
blue sky laws, or other anti-fraud federal and state statutes, the discussion of materiality
will not treat the latter separately. These two elements of the fraud action are carved out
for special attention because a failure to consider them properly will contribute to the
conclusion that the Shari’ah black box poses no great risk to U.S. companies involved in
SCF. This conclusion, if reached without due consideration of the matters raised herein,
would be faulty and very costly.
1. Materiality
a. The Supreme Court’s standards
Materiality is a fundamental element for an action alleging a failure to disclose under the
securities laws. The essential elements of such a claim might be, in addition to those set
forth above in the hypothetical, as follows:
143 Id. § 771.
144 See generally LOSS & SELIGMAN, supra note 5, at 1217-1239.
145 Supra notes 101-104 and accompanying text.
146 LOSS & SELIGMAN, supra note 5, at 1273-1301; see also Heuer,, Reese & Sale, supra note
104.
147 15 U.S.C. § 78ff(a); see also Heuer, Reese & Sale, supra note 104, at [page number] & nn.53-
54.
3 6
(1) Plaintiff bought shares in a closed-end mutual fund which represented
itself to be Shari’ah-compliant.
(2) An important part of these representations was the high-repute of the
Shari’ah advisory board members who were to watch over the fund’s
Shari’ah compliance.
(3) Various representations by the defendant financial institution and its
agents and representatives spoke of the ethical and socially responsible
nature of Shari’ah.
(4) It was subsequently discovered and made public that the Shari’ah
advisory board members all treated the rulings and pronouncements of Ibn
Taymiyyah, a fourteenth-century Hanbali Shari’ah authority and scholar
“with strikingly modern-sounding views” on commerce and finance148, as
authoritative. It was also discovered and made public that Ibn Taymiyyah
was a key Shari’ah authority for most of the terrorists associated with al
Qaeda. Ibn Taymiyyah, it turns out, was a leading advocate of a Shari’ah
centered political organization for Muslims which would declare holy war
against infidels and Muslims who rejected Shari’ah. In fact, all sorts of
“Islamists” who have declared war on the U.S. and seek the establishment
of a worldwide Caliphate are students and followers of the Shari’ah “rules
and principles” espoused by Ibn Taymiyyah insofar as he advocates
Muslims to war against infidels.149
(5) There is a consensus among Shari’ah authorities from all schools of
Shari’ah jurisprudence that forced subjugation or Jihad against non-
Muslims is obligatory when efforts to peacefully convert the non-Muslims
fail and war is a viable option.
In addition to these allegations, which would support an SEC enforcement action or a
private right of action for rescission, a plaintiff might opt to pursue damages. In such a
case, one might anticipate the following: When the information alleged above became
public knowledge, the fund suffered irreparable reputational damage and many of the
U.S. investors sold their shares in the mutual fund, causing the value of the traded shares
to plummet. The complaint would also allege that the plaintiff purchased shares in the
mutual fund without knowing anything about Shari’ah other than what the defendants
represented to the public. Since the defendants promoted their Shari’ah authority board
members as highly respected scholars and authorities in their field, and since these
authorities ruled that Shari’ah forbade interest and excessive speculation in investments,
and also prohibited investing in various “vice” industries, the plaintiff reasonably relied
on these representations in the belief that Shari’ah was a “socially responsible” business
practice and worth utilizing as an investment “screen”. Had the plaintiff known the facts
about Shari’ah as they have now come to light, plaintiff would never have invested in a
148 VOGEL & HAYES, supra note 18, at 38.
149 See Coughlin, supra note 24, at 147-150.
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Shari’ah-compliant mutual fund. In addition to damages, the plaintiff would apply to
certify a class of similarly situated investors.
The first issue confronting the plaintiffs under Rule 10b-5 would be whether the
omissions of fact relating to Shari’ah doctrine relative to the treatment of apostates (both
non-Muslims and Muslims) were material. The leading decision in this area is TSC
Industries, Inc. v. Northway, Inc.,150 where the Supreme Court addressed whether a
failure to disclose in the context of a proxy solicitation was material.
The Court began by rejecting what it considered to be too low a threshold for materiality
as adopted by the lower court. The Court considered a standard of “all facts which a
reasonable shareholder might consider reasonable”151 “‘too suggestive of mere
possibility, however unlikely.’”152 The Court went on to explain in detail the objective
standard it chose for materiality:
An omitted fact is material if there is a substantial likelihood that a
reasonable shareholder would consider it important in deciding how to
vote. . . . Put another way, there must be a substantial likelihood that the
disclosure of the omitted fact would have been viewed by the reasonable
investor as having significantly altered the "total mix" of information
made available.153
Arguably, the question whether the Shari’ah in SCF is a material fact that ought to be
disclosed will rest on one of two analytical approaches, or possibly both. The first
approach seeks to determine the materiality of Shari’ah in principle. It asks: Would a
reasonable post-9/11 investor consider the connection between Shari’ah and SCF
important to his or her decision to invest? In other words, would a reasonable investor
looking to invest in something promoted as “Shari’ah-compliant” want to know what
Shari’ah and its “rules and principles” say about constitutional government, treatment of
infidels, the Law of Jihad, and the use of suicide-homicide bombers, and other acts of
terrorism? Would the reasonable investor want to know about the published statements
by international terrorist leaders citing Shari’ah authorities as justification for their holy
war against the U.S. and other Western nations? These and similarly phrased questions
all attempt to get at the associational link between Shari’ah in principle as an
authoritative set of rules and principles advocating violence and SCF. If in fact such an
association exists, would it be material information to a reasonable investor?154
150 426 U.S. 438 (1976).
151 485 U.S. 224, 445 (1988) (emphasis in the original).
152 Id. at 449 (quoting from 478 F. 2d at 1302).
153 Id. at 445-449 (footnotes and citations omitted).
154 A related question would be who decides and how does one decide what Shari’ah is? This is
not specific to the query of materiality. As noted supra, if a financial institution relies upon
specific Shari’ah authorities, the question might be as simple as determining what these specific
Shari’ah authorities consider to be authentic and authoritative Shari’ah rulings on Jihad,
terrorism, and violence against non-Muslims and non-Shari’ah-compliant Muslims. Aside from a
careful examination of the rulings on these subjects issued by the relevant Shari’ah authorities, a
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The second analysis relevant to materiality goes beyond the association in principle of
SCF with Shari’ah and its call to violence and asks whether there is enough evidence of
association in fact. This analysis asks: Is the nexus between Shari’ah and violence so
contingent or speculative that it would render any theoretical association between
Shari’ah and violence immaterial? This is another way of analyzing the argument often
made against any association between Shari’ah or Islam and violence. In the context of
Shari’ah, the argument is made that Shari’ah can be interpreted in peaceful ways or in
violent ways, and that those Shari’ah authorities who interpret Shari’ah violently and in
ways that would shock the conscience of a reasonable U.S. investor are the extremists
and represent such a small percentage of the recognized Shari’ah authorities that it would
render any theoretical link between Shari’ah and violence against non-Muslims and non-
Shari’ah-compliant Muslims so tenuous as to be immaterial to a reasonable investor. In
short, this is an argument that accepts that violence is associated in principle with
Shari’ah,155 but argues that the association is less than material because it is not
representative of Shari’ah as espoused by the vast majority of contemporary Shari’ah
authorities.
While Coughlin’s investigation and documentation would demonstrate this argument to
be lacking evidentiary credibility, the analysis in a courtroom would turn on an
examination of the facts and the law. As the Court opined in TSC Industries, “[t]he issue
of materiality may be characterized as a mixed question of law and fact, involving as it
does the application of a legal standard to a particular set of facts.”156 In addition to a
simple factual showing that Islamic terrorists base their raison d’être for violence on the
dictates of Shari’ah as expressed by the classical Shari’ah authorities and some
contemporary ones, the fact question as presented might also be addressed by introducing
evidence establishing what the contemporary Shari’ah authorities consider to be the
purposes and authorized methods of Shari’ah. This question might be presented to a jury
by introducing evidence (i) of the rulings of the contemporary Shari’ah authorities, (ii) of
the rulings of classical Shari’ah authorities upon which the contemporary authorities
have relied, and (iii) of Shari’ah in actu, which would include a brief on Muslimdominated
regimes generally recognized as following Shari’ah, including their Shari’ahproblem
in any event if they have not published rulings in these areas, one would be well-advised
to look to the classical Shari’ah authorities upon which these contemporary Shari’ah authorities
rely as authoritative in their SCF rulings. While such a reliance might not be dispositive (i.e., a
Shari’ah authority might rely on Ibn Taymiyyah for purposes of determining what kind of
nominate contract Shari’ah allows for any given transaction, but in fact reject Ibn Taymiyyah’s
rulings on Jihad and war against the infidels). But at the very least, it raises an important fact
question for the reasonable investor that might very well rise to the level of materiality: Do the
Shari’ah authorities of the particular financial institution consider Ibn Taymiyyah’s Shari’ahbased
rulings on war against non-Muslims and non-Shari’ah compliant Muslims authoritative? If
not Ibn Taymiyyah’s, whose?
155 This is procedurally akin to a defendant’s position on a motion to dismiss or for summary
judgment. Assuming all the allegations are true, as a matter of law, there is no actual evidence
that Shari’ah is the cause of violence rather than its excuse.
156 426 U.S. 438, 450 (1976).
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based criminal codes and punishments and their track record for violations of the basic
norms of the Law of Nations and human decency.157
The legal question presented by this second analysis will not be different in kind from the
first analytical approach, which examines the association in principle between Shari’ah,
its call to violence, and SCF. In both, one must determine if the law requires disclosure of
qualitatively material facts as opposed to quantitatively material facts. Quantitative
materiality requires companies only to disclose hard, empirical facts such as financial
data and any criminal convictions of management personnel. Qualitative materiality
requires a fuller disclosure of behavior that might be considered unethical or even illegal
but which has not yet resulted in an actual conviction.158
While qualitative materiality is frowned upon by the courts and commentators because it
renders the duty to disclose open to wholesale uncertainty about what must be disclosed
in the first instance, the problem of disclosure for the Shari’ah-compliant financial
institution is not circumscribed by this concern. Disclosure remains a significant legal
issue for the company looking to promote its SCF business (or simply to disclose publicly
the involvement in SCF) because of the difference between whether a duty to disclose
exists in the first instance and what must be disclosed to make a partial disclosure not
misleading to the reasonable investor.159 Thus, to the extent an SCF business actively
promotes its SCF business or includes SCF within the risk factors in its SEC filings, this
disclosure opens the door to a full and accurate disclosure of all facts which a reasonable
investor would find material. It hardly seems in doubt that a post-9/11 investor, when
contemplating an investment in something represented as Shari’ah-compliant, would
consider material any factual link between Shari’ah and the call for violence against non-
Muslims and non-Shari’ah-compliant Muslims, or more specifically against the U.S. or
U.S. interests abroad. Indeed, it would be improbable that a post-9/11 investor would not
want to know what Shari’ah says about the Law of Jihad and the use of Shari’ah by
Islamic terrorists even if the reporting company made no disclosure or representation
about being Shari’ah-compliant. The fact of Shari’ah compliance would likely be
sufficiently material for the duty of disclosure to exist independently of any partial
representation.160
157 See supra note 86; supra notes 249-250 and accompanying text.
158 See generally LOSS & SELIGMAN, supra note 5, at 171-174. For a thorough discussion of the
quantitative-qualitative distinction in disclosure, see John M. Fedders, Qualitative Materiality:
The Birth, Struggles, And Demise Of An Unworkable Standard, 48 CATH. U.L. REV. 41 (1998).
159 Common law fraud did not originally impose a duty to disclose; rather, once a statement
represented something as fact, it had to be truthful. Materiality gets at “truthfulness” in that “halftruths”
can be as misleading as false statements. The development of the law on the disclosure of
omitted facts has always lagged behind the duty to disclose the whole of a truth partially told. For
a discussion in this development relative to securities fraud cases, see LOSS & SELIGMAN, supra
note 5, at 910-918.
160 This would be the case whether a company made no disclosure at all or represented itself as
focused on “socially responsible” or “ethical” investing without any mention of Shari’ah. If the
business model was in fact based upon Shari’ah, this would remain a material fact.
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The confusion at a procedural level for the legal advisor attempting to weigh the
materiality issue within the overall analysis of liability exposure might be the existence of
counterfactual claims suggesting that Shari’ah has a peaceful face in addition to its
connection to Islamic terror. But these “counter-facts” would simply create a fact
question. This suggests that a well-pled complaint alleging a sufficient nexus between
SCF, Shari’ah, terror, and violence would survive a motion for summary judgment. This
seems especially true given the effectiveness of Shari’ah-inspired terrorists to convert
calls for violence based upon Shari’ah into actual violence.
b. Global Security Risk: a material fact?
The close nexus in the hypothetical factual predicate for this discussion between Shari’ah
and global terrorism is, as explained above, more than just theoretical. Efforts by
corporate legal counsel to dismiss these concerns will invariably run up against the wall
of common understanding linking in material ways the violent and oppressive world of
Shari’ah one hears about in the public media161, terrorism committed in the name of
Shari’ah162, Shari’ah itself163, and something calling itself SCF. This common
understanding has already begun to articulate itself in the debate over materiality in the
context of what is a material or relevant disclosure with respect to shareholder proxy
statements.
In at least two instances, the New York City Comptroller, as the custodian and trustee of
several major New York City employee pension funds which had acquired substantial
stock in Halliburton Company and General Electric, demanded that these two U.S. multinational
corporations doing business in Iran approve a shareholder proposal at their
respective annual meetings to examine the “potential financial and reputational risks”
associated with doing business in terror-sponsoring countries.164 The first effort was
directed against Halliburton and began in late 2002, culminating in a final negative
161 Recent media stories about the Shari’ah criminal law include only recently a Muslim convert
to Christianity sentenced to death, a rape victim sentenced to lashes, and thieves having their
hands amputated. See, e.g., Josh Gersten, Widespread Outrage At Afghan Facing Death For
Abandoning Islam, N.Y. SUN, Mar. 21, 2006. For a scholarly look at the Shari’ah criminal law
from the time of the Ottoman Empire until today, see RUDOLPH PETERS, CRIME AND
PUNISHMENT IN ISLAMIC LAW: THEORY AND PRACTICE FROM THE SIXTEENTH TO THE TWENTYFIRST
CENTURY (2005).
162 See MARY HABECK, KNOWING THE ENEMY: JIHADIST IDEOLOGY AND THE WAR ON TERROR
(2006).
163 For Shari’ah as expressed by Shari’ah authorities over the past millennium, see DAVID COOK,
UNDERSTANDING JIHAD; PETERS, supra note 138; Coughlin, supra note 24, at 83-223. See
generally, THE LEGACY OF JIHAD 141-367 (2005).
164 The SEC documents from which this narration is drawn can be found through a Lexis search:
for the Halliburton “No Action Letter” file, see 2003 SEC No-Act. LEXIS 433 [hereinafter
Halliburton No-Action File]. For General Electric, see 2005 SEC No-Act. LEXIS 137
[hereinafter GE No-Action File]. For a broader article discussing these cases in some detail in the
context of compliance by foreign subsidiaries of U.S. corporations, see Terence J. Lau,
Triggering Parent Company Liability Under United States Sanctions Regimes: The Troubling
Implications Of Prohibiting Approval And Facilitation, 41 AM. BUS. L.J. 413 (2004).
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response to Halliburton’s request for an SEC no-action letter in March 2003. The denial
of a no-action letter was perhaps influenced by the Comptroller’s statement that “[t]he
link between Iran and Halliburton is of special interest to the public, including
institutional, professional and non-professional investors, who are paying a great deal
more attention to the relationship between their investments and terrorism.” 165
Almost two years later, the SEC took the same hands-off policy when GE came knocking
at the door also seeking a no-action letter to support its contention that it need not include
a proxy proposal by the Comptroller at its annual shareholders’ meeting.166 In its
correspondence in opposition to GE’s request, the Comptroller quoted at length from the
Congressional Conference Report on the 2004 Budget, which requested that the SEC
establish an Office of Global Security Risk to evaluate the risks caused by the conduct of
business operations in terrorist states.167 The SEC denied GE’s no-action letter and
ultimately established an Office of Global Security Risk, the purpose of which is to
“monitor whether the documents public companies file with the SEC include disclosure
of material information regarding global security risk-related issues.” 168
165 Letter from Janice Silberstein, Assoc. Gen. Counsel, City of N.Y., Office of the Comptroller,
to Sec. and Exch. Comm’n, Div. of Corporate Fin., Office of the Chief Counsel (Feb. 7, 2003), in
Halliburton No-Action File, supra note 164.
166 See GE No-Action File, supra note 164.
167 Letter from Richard S. Simon, Deputy Gen. Counsel, The City of N.Y., Office of the
Comptroller, to Sec. and Exch. Comm’n, Div. of Corporate Fin., Office of the Chief Counsel
(Dec. 10, 2004), in GE No-Action File, supra note 164.
168 U.S. Securities and Exchange Commission, Office of Global Security Risk,
http://www.sec.gov/divisions/corpfin/globalsecrisk.htm (last visited Jan. 30, 2008). In this
context, the SEC proposed the following:
II. Disclosure of Business Activities in or With Countries Designated as State
Sponsors of Terrorism
The federal securities laws do not impose a specific disclosure requirement that
addresses business activities in or with a country based upon its designation as a State
Sponsor of Terrorism. However, the federal securities laws do require disclosure of
business activities in or with a State Sponsor of Terrorism if this constitutes material
information that is necessary to make a company's statements, in the light of the
circumstances under which they are made, not misleading. [Note 6 citation appears here
in the text. See below.] The term “material” is not defined in the federal securities laws.
Rather, the Supreme Court has determined information to be material if there is a
substantial likelihood that a reasonable investor would consider the information important
in making an investment decision or if the information would significantly alter the total
mix of available information. [Note 7 citation appears here in the text. See below.]
The materiality standard applicable to a company’s activities in or with State
Sponsors of Terrorism is the same materiality standard applicable to all other corporate
activities. Any such material information not covered by a specific rule or regulation
must be disclosed if necessary to make the required statements, in the light of the
circumstances under which they are made, not misleading. The materiality standard’s
extensive regulatory and judicial history helps companies and their counsel to interpret
and apply it consistently, and we remain committed to employing this standard to
company disclosure regarding business activities in or with State Sponsors of Terrorism.
4 2
It is clear that U.S. companies can no longer consider their associations with countries or
entities tainted by terror a private, non-material, or irrelevant matter. While the courts
have not yet entered the fray, the executive and legislative branches have laid down some
markers. This suggests that the closer a company gets to a “state sponsor of terror”, the
more it has to disclose. Prudent counsel suggests that the closer a company gets to any
association with terror, the more it has to disclose. The obvious question raised by the
two proxy examples above would be: If a shareholder submits a proxy proposal to a
publicly reporting financial institution involved in SCF requiring a full study of the risks
associated with Shari’ah, will the company have legitimate grounds to argue that the
risks of Shari’ah and its connection to terror are not relevant? Outside of the proxy arena,
if a company engages in SCF and represents to the public that Shari’ah is a standard set
by Shari’ah authorities relied upon by the company, has the company disclosed enough
about Shari’ah to tell the whole story? Given the hypothetical this analysis has been
working with, the answer appears to be “no”.
2. Scienter
Unlike materiality, which is an element in any type of fraud action, scienter, or intent, is a
critical element of the common law and of most statutory provisions imposing liability on
a wrongdoer.169 As understood by the common law, a plaintiff’s claim for deceit could
only survive a motion to dismiss if the pleadings alleged that the defendant knew the
falsity of the representation and that the false representation was made in an effort to
induce reliance by the plaintiff. Over time, this standard has been relaxed to include not
merely false representations but also half-truths. This means that having opened the door
to a representation, the putative defendant must be certain to have told the whole truth, or
at least the whole material truth.170
Although the Commission is well positioned to review disclosure relating to business
activities regardless of the country in which they are conducted, we do not have the
expertise or information necessary to identify the particular countries whose governments
have funded, sponsored, provided a safe haven for, or otherwise supported terrorism. Nor
is it the Commission’s role to determine the degree to which a public company’s business
activities may support terrorism or may be inconsistent with U.S. foreign policy or U.S.
national interests.
Note 6: Rule 408 of Regulation C, [17 CFR 230.408] and Rule 12b-20 under the
Securities Exchange Act of 1934 [17 CFR 240.12b-20].
Note 7: TSC Industries v. Northway, Inc., 426 U.S. 438 (1976). It has also held that
materiality of contingent or speculative events or information depends on balancing the
probability that the event will occur and the expected magnitude of the event. Basic v.
Levinson, 485 U.S. 224, 238 (1988).
Concept Release on Mechanisms to Access Disclosures Relating to Business Activities in or With
Countries Designated as State Sponsors of Terrorism, 72 Fed. Reg. 65862, 65863 (proposed Nov.
23, 2007) (to be codified at 17 C.F.R. pts. 228, 229, 230, 239, 240 & 249) (footnotes omitted).
169 See generally LOSS & SELIGMAN, supra note 5, at 910-11, 1018-31.
170 Supra note 159.
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But the question remains: Having omitted some important part of the story, and assuming
that the omitted part was material, did the defendant withhold the omitted part (a)
knowingly and (b) with intent to deceive? Successful civil and criminal fraud litigation is
as much about properly alleging scienter as it is proving it.171 Judges will decide the
former; jurors are most likely to decide the latter172.
Today, fraud claims alleging a failure to disclose might be based upon violations of
federal securities laws, state blue sky laws, state consumer protection laws, or other
federal and state anti-fraud statutes. While the common law has generally moved away
from requiring a specific intent to defraud and toward a standard of recklessness -- and in
those jurisdictions which have adopted Section 552 of the Restatement (Second) Of
Torts173 the move has included even negligent misrepresentation -- specific claims under
federal or state anti-fraud statutes will vary depending upon the statute, the specific
jurisdiction, and whether the action is administrative, civil, or criminal.
For example, under federal securities laws, there are statutes and rules permitting SEC
administrative and civil enforcement actions and private causes of action that do not
impose a requirement to plead or prove scienter. Thus, under the 1933 Act, which has
arguably become far more important for those seeking to pursue class action claims174,
Sections 17(a)(2) and (a)(3) are free of any scienter requirement for SEC civil actions
and, to the extent that a private right of action exists, the no-scienter rule is likely to
extend to private plaintiffs.175 Also, Section 11, which relates to misrepresentations in a
registration statement, imposes absolute liability on the issuer without any reference to
scienter, but does provide for reasonable care defenses as a kind of substitute for scienter
for other defendants.176 Section 12(2) imposes liability without reference to scienter in
171 This is especially true after the passage of the Private Securities Litigation Reform Act of 1995
(PSLRA), which ratcheted up the scienter pleadings requirements and froze discovery during a
defendant’s motion to dismiss to eliminate frivolous suits and to eliminate the “leverage”
plaintiffs use by propounding reams of discovery requests early on to tie-up company
management and extort a settlement. For a good discussion of the pleadings requirements post-
PSLRA, see Ray J. Grzebielski & Brian O. O'Mara, Whether Alleging "Motive and Opportunity"
Can Satisfy the Heightened Pleading Standards of the Private Securities Litigation Reform Act of
1995:Much Ado About Nothing, 1 DEPAUL BUS. & COM. L.J. 313 (2003).
172 Certainly this is true in the Second Circuit Court of Appeals, given the ruling in Press v.
Chemical Investment Services Corp., 166 F.3d 529, 538 (2d Cir. 1999) (“‘Whether or not a given
intent existed is, of course, a question of fact.’” (quoting SEC v. First Jersey Sec., Inc., 101 F.3d
1450, 1467 (2d Cir. 1996))); see also id. (“‘Whether a given intent existed is generally a question
of fact.’” (quoting In re Time Warner, 9 F.3d 259, 270-71 (2d Cir. 1993))). For an argument in
favor of the Second Circuit’s approach to scienter, see Daniela Nanau, Analyzing Post-Market
Boom Jurisprudence in the Second and Ninth Circuits: Has the Pendulum Really Swung Too Far
in Favor of Plaintiffs?, 3 CARDOZO PUB. L. POL'Y & ETHICS J. 943 (2006).
173 RESTATEMENT (SECOND) OF TORTS §552(1) (1977).
174 See supra notes 171-172; see also Cook, supra note 105 (providing an overall examination of
the jurisdictional issues raised by the recent federal legislation affecting class actions alleging
securities fraud).
175 See generally LOSS & SELIGMAN, supra note 5, at 1019 & n.345.
176 See generally id. at 1227-39 (except the discussion on “expertizing” at 1232-33).
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public offerings177 but provides an out for a defendant who can “sustain the burden of
proof that he did not know, and in the exercise of reasonable care could not have known,
of such untruth or omission.”178
Another serious avenue for enforcement that avoids the scienter issue arises under the
Investment Advisors Act of 1940 (“Investment Advisors Act”). Fund managers who
embrace SCF while ignoring Shari’ah as a material part of the disclosure will likely face
serious scrutiny as the SEC and large institutional investors come to understand the
intimacy between the terms “Shari’ah-compliant”, “Islamic finance”, and even “socially
responsible Islamic investing” and the Shari’ah witnessed in Iran, Saudi Arabia, and
Sudan. Indeed, an SCF investment or business which attempts to disguise the “Shari’ah”
and utilize a less emotionally charged term has added to its exposure, since that would be
circumstantial evidence that the putative defendants knew of the dangers of Shari’ah and
sought to minimize them by using a more acceptable public relations-sensitive
nomenclature.
Specifically, investment advisors, including those who might otherwise fall within a
registration exemption, come within the Act’s anti-fraud provisions. Thus, under Rule
206(4)-1:
a. It shall constitute a fraudulent, deceptive, or manipulative act, practice,
or course of business within the meaning of section 206(4) of the Act for
any investment adviser registered or required to be registered under
section 203 of the Act, directly or indirectly, to publish, circulate, or
distribute any advertisement:
. . .
5. Which contains any untrue statement of a material fact, or which
is otherwise false or misleading.179
Rule 206(4)-8, captures the pooled investment fund advisors:
a. Prohibition. It shall constitute a fraudulent, deceptive, or manipulative
act, practice, or course of business within the meaning of section 206(4) of
the Act for any investment adviser to a pooled investment vehicle to:
1. Make any untrue statement of a material fact or to omit to state a
material fact necessary to make the statements made, in the light of
the circumstances under which they were made, not misleading, to
177 Per its terms, Section 12(2) creates civil liability for misrepresentations when someone “offers
or sells a security” and does so “by means of a prospectus or oral communication.” 15 U.S.C.S. §
77l(a)(2); see also Gustafson v. Alloyd Co., 513 U.S. 561, 569 (1995) (stating that a “prospectus”
is a specific kind of document under the 1933 act and misrepresentations of the written kind must
be in the prospectus to be the basis for an action under Section 12(2)).
178 15 U.S.C. § 77l(a)(2) (2006).
179 17 C.F.R. § 275.206(4)-1 (2008).
4 5
any investor or prospective investor in the pooled investment
vehicle; or
2. Otherwise engage in any act, practice, or course of business that
is fraudulent, deceptive, or manipulative with respect to any
investor or prospective investor in the pooled investment
vehicle.180
As the Supreme Court made clear in SEC v. Capital Gains Research Bureau,181 the
Investment Advisors Act was meant to safeguard the fiduciary relationship between the
advisor and the investor. The nature of the SEC proceeding, the heightened duty of such
fiduciaries, and the purposes of the act eliminate the need to show intent to injure as in
common law fraud.182 The exposure of investment advisors to the claim that they have a
duty to disclose all of the material facts about Shari’ah prior to any investment in an SCF
fund, securitization, or company seems quite substantial, which is further highlighted by
the complete lack of attention given the duty and its breach by the SCF industry.
While scienter’s common law and statutory roles appear greatly diminished in the
contexts discussed above, that is not the case for implied rights of action under Rule 10b-
5. Congress and the Supreme Court have gone a long way to gut both the 1934 Act and
the blue sky laws of their private class action fear factor -- in part by requiring strict
pleading of all necessary elements, including scienter.183 The attorney representing the
financial institution must keep in mind, however, that the SEC and institutional plaintiffs
with significant investments at stake will continue to employ Rule 10b-5 and state
securities anti-fraud provisions. Institutional investors with large investment portfolios
are less inclined to turn to class actions when they can bring far more manageable private
civil claims that carry enough investment clout to make a difference to the defendant.
Moreover, even after the Supreme Court’s decision in the oft-cited Ernst & Ernst v.
Hochfelder case184, while a Rule 10b-5 allegation requires more than negligence, a
reckless disregard for the truth likely suffices. This is as much about artful pleading as it
is about nailing down the legal standard, especially after a financial institution opens the
180 For the SEC Final Rule, see 72 Fed. Reg. 44,756, 44,761 (Sep. 10, 2007) (codified at 17
C.F.R. pt. 275).
181 375 U.S. 180, 195 (1963).
182 Id. For a discussion of whether there is a private right of action to void contracts under Section
215 of the Investment Advisors Act, see Transamerica Mortg. Advisors (tama) v. Lewis, 444 U.S.
11, 18-19 (1979); see also LOSS & SELIGMAN, supra note 5, at 1241-47.
183 See supra note 171; see also Jeffrey W. Stempel, Class Actions and Limited Vision:
Opportunities for Improvement Through a More Functional Approach to Class Treatment of
Disputes, 83 WASH. U. L. REV. 1127 (2005) (discussing the Class Action Fairness Act of 2005
(CAFA)).
184 425 U.S. 185 (1976); see also Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033 (7th
Cir. 1977) (stating the classic “recklessness” standard as follows: “[H]ighly unreasonable
[conduct], involving not merely simple, or even inexcusable negligence, but an extreme departure
from the standards of ordinary care, and which presents a danger of misleading buyers or sellers
that is either known to the defendant or is so obvious that the actor must have been aware of it”).
4 6
door to a partial but misleading truth.185 Thus, a financial institution that recognizes the
threshold duty to disclose something about Shari’ah and the Shari’ah authorities who set
the standards for the particular SCF investment or business must be extremely careful to
capture all of the material facts about Shari’ah, its purposes, and its methods. Failure to
recognize an extant connection between Shari’ah and violence after representing
Shari’ah as divine Islamic law based on the Qur’an, the Sunna, and legal rulings of the
competent Shari’ah authorities will suffice to satisfy the scienter requirement---at least at
the pleadings stage.
Recklessness, especially in a case where a representation was made but without all the
requisite material facts, is a notoriously fact-based standard that allows a showing of
proof through circumstantial evidence.186 The caselaw suggests a “totality of the
circumstances” test where a variety of factors come into play to establish recklessness.187
The specific factors typically cited include how material the omission was; how available
the omitted facts were to the defendant; whether there was an extant standard of care in
the industry giving rise to a duty to disclose the omitted facts; how egregious the breach
was; and what the the likely consequences were of not disclosing the material facts.
Rule 10b-5 is important because it operates as a “catch-all” anti-fraud statute with an
implied private right of action. But beyond Rule 10b-5, there are many state securities
laws which require no scienter and are broader in their reach than Rule 10b-5. Arizona’s
blue sky anti-fraud provisions have been given an expansive reach to get at all kinds of
securities fraud without the burden of scienter.188 Arizona blue sky laws also permit
punitive damages.189 In addition, at least three states provide for a securities fraud claim
185 See supra note 159; see also City of Monroe Employees Ret. Sys. v. Bridgestone, 399 F.3d 651,
687 (6th Cir. 2005). In the Bridgstone case, the court quoted Rubin v. Schottenstein, 143 F.3d
263, 267 (6th Cir. 1998) (en banc), as follows:
The question thus is not whether a [defendant’s] silence can give rise to liability, but
whether liability may flow from his decision to speak . . . concerning material details . . .,
without revealing certain additional known facts necessary to make his statements not
misleading. This question is answered by the text of [SEC] Rule 10b-5(b) itself: it is
unlawful for any person to “omit to state a material fact necessary in order to make the
statements made, in the light of the circumstances under which they were made, not
misleading . . . .”
Bridgestone, 399 F.3d at 687.
186 See Bridgestone, 399 F.3d at 669 (quoting Helwig v. Vencor, Inc., 251 F.3d 540, 555 (6th Cir.
2001)), wherein the court explained that “[a]s for materiality, whether or not a statement is
material turns on ‘a fact-intensive test.’” The court also stated that “‘[m]ateriality depends on the
significance the reasonable investor would place on the withheld or misrepresented information.’”
Id. (quoting Basic Inc. v. Levinson, 485 U.S. 224, 240 (1988)). That is, would the information,
had it been presented accurately, have “‘significantly altered the ‘total mix’ of information made
available?’” 251 F.3d at 563 (quoting Basic, 485 U.S. at 231-32).
187 See Bridgestone, 399 F.3d at 669 (citing PR Diamonds, Inc. v. Chandler, 364 F.3d 671, 680
(6th Cir. 2004)).
188 Ariz ARIZ. REV. STAT. ANN. § 44-1991 (1999); see also Richard G. Himelrick, Arizona
Securities Fraud Liability: Charting a Non-Federal Path, 32 ARIZ. ST. L.J. 203 (2000).
189 See id. at 230 & n. 186.
4 7
under their respective consumer anti-fraud statutes190, of which two have a private right
of action allowing for punitive damages.191 Even a state like California, which does not
recognize securities fraud as a cause of action under its consumer fraud statute, will allow
a consumer fraud claim relating to a “holder” of securities where the allegation is of
fraud, but not in connection with the “sale” or “purchase” of a security.192 These state
consumer fraud actions are effective weapons in the hands of a sophisticated plaintiffs’
bar against financial institutions treading down the seemingly golden path of SCF.
D. Sedition: Shari’ah as the advocacy of the violent overthrow of the U.S.
government
The Smith Act of 1940 makes it criminal to “knowingly or willfully advocate[ ], abet[ ],
advise[ ], or teach[ ] the duty, necessity, desirability, or propriety of overthrowing or
destroying the government of the United States”.193 The Supreme Court has taken four
occasions to review cases prosecuted under the Smith Act. In the first case, Dennis v.
United States,194 the Court heard appeals from Communist Party leaders who had been
convicted of violating the Smith Act and whose conviction had been affirmed by the
lower court. The Court examined the First Amendment and other constitutional
challenges, upheld the statute as constitutional, and affirmed the convictions.
The second time the Court took a look at the Smith Act was six years later in the case of
Yates v. United States.195 By this time, however, the Court was now under the spell of
Chief Justice Earl Warren and the other liberal Justices of the time. They had already
tested their mettle in Brown v. Board of Education196 some three years earlier, and one
could reasonably have wondered whether the Court would sustain a First Amendment
challenge and effectively overrule Dennis.
The Court did not even address the First Amendment issue. What the Court did was to
limit the Smith Act to cases where the advocacy for the overthrow of the government was
more than merely theoretical and to require a nexus between the advocacy and some
action that was being urged to achieve the treasonous goal.
190 See supra note 112.
191 For case law regarding Illinois’ private right of action, see In re CLDC Management Corp., 18
B.R. 797, 799-800 (Bankr. D. Ill. 1982) (implied private right of action allowed); Martin v.
Heinold Commodities, 163 Ill. 2d 33, 67 (1994) (punitive damages allowed). For case law
regarding Arizona’s private right of action, see Holeman v. Neils, 803 F. Supp. 237 (D. Ariz.
1992) (implied private right of action allowed); Dunlap v. Jimmy GMC of Tucson, Inc., 666 P.2d
83 (Ariz. Ct. App. 1983) (punitive damages allowed).
192 Strigliabotti v. Franklin Res., Inc., No. C 04-00883 SI, 2005 U.S. Dist. LEXIS 9625 (N.D. Cal.
March 7, 2005).
193 18 U.S.C. § 2385 (2006).
194 341 U.S. 494 (1951).
195 354 U.S. 298 (1957)
196 Brown v. Bd. of Educ., 345 U.S. 972 (1953).
4 8
In Scales v. United States,197 the Court reexamined the Smith Act. In this case, the
defendant sought to have his conviction for being a member of the Communist Party set
aside on statutory, constitutional, and procedural grounds. While the procedural aspects
are not relevant to this discussion, the statutory and constitutional parts of the case are.
The first argument raised by the defendant-petitioner was based on the claim that another
federal statute had been enacted providing that mere membership in the Communist Party
would not constitute a per se violation of any federal statute.198 From this, the petitioner
concocted the argument that the Smith Act’s membership clause had been repealed pro
tanto. The Court rejected this argument on several grounds, but most importantly because
the Court found that the petitioner’s Smith Act conviction was for being a member of an
organization which called for the violent overthrow of the U.S. There was nothing unique
about the Communist Party except its doctrine for violent overthrow; the Smith Act
applied to any organization, not just to the Communist Party.
The petitioner also challenged his Smith Act conviction on per se constitutional
grounds.199 The petitioner argued that the membership clause of the Smith Act violated
his Fifth and First Amendment rights. The Fifth Amendment claim essentially boiled
down to this: Although the trial court instructed the jury that the defendant had to be an
“active member” of the criminal group, in accord with the earlier decision in Yates which
required a nexus between advocacy and action, the trial court did not require that the
defendant actually participate in the criminal activity. It was enough that the defendant
knew of the criminal designs of the group at large and that the defendant was an active
member, even if such activity was wholly legal. As such, the petitioner argued that this
violated his Fifth Amendment rights to due process because it convicts a person for mere
association and not overt criminal activity. The First Amendment claim was similarly an
argument that his right to freedom of association was unconstitutionally infringed by
virtue of the threat of criminal prosecution for mere non-criminal membership.
The Court rejected the argument, asserting that:
Any thought that due process puts beyond the reach of the criminal law all
individual associational relationships, unless accompanied by the
commission of specific acts of criminality, is dispelled by familiar concepts
of the law of conspiracy and complicity. . . . In this instance it is an
organization which engages in criminal activity, and we can perceive no
reason why one who actively and knowingly works in the ranks of that
organization, intending to contribute to the success of those specifically
illegal activities, should be any more immune from prosecution than he to
whom the organization has assigned the task of carrying out the substantive
criminal act.200
197 367 U.S. 203 (1961).
198 367 U.S. at 207-210. The intervening statute purportedly overruling the Smith Act
membership clause, the Internal Security Act of 1950, 64 Stat. 987 (codified at 50 U.S.C. § 781),
was repealed by Act of Dec. 17, 1993, Pub. L. No. 103-199, Title VIII, § 803(1), 107 Stat. 2329.
199 The petitioner also raised “as applied” claims but these boiled down to an evidentiary analysis.
200 367 U.S. at 225.
4 9
Thus, the Court concluded that a Smith Act membership conviction will stand when (a)
the defendant knows (b) that the group to which the membership attaches intends
criminal purposes and (c) that the defendant’s membership evidences a specific intent to
promote the criminal goals of the organization (d) even if the defendant’s membership
and involvement is not itself criminal activity.
In Noto v. United States,201 the fourth of the Smith Act cases to come before the Court
and a companion case to Scales, the Court overturned the conviction because it found the
nexus between the theory of violence and the actual call to violence too remote. Quoting
from its opinion in Scales, the Court explained that the advocacy must be:
“not of . . . mere abstract doctrine of forcible overthrow, but of action to
that end, by the use of language reasonably and ordinarily calculated to
incite persons to . . . action” immediately or in the future.202
Given this judicial treatment of the Smith Act, a lawyer representing a U.S. company
which retains Shari’ah authorities must be critically aware of several threatening
circumstances. One, if the Shari’ah authorities advocate the Law of Jihad against the
U.S., this advocacy probably falls within the Smith Act as refined by the Supreme Court.
The argument here rests on two prongs. First, the Shari’ah authorities are not mere
advocates of theory or theology but authorized religious leaders who have been retained
by the company precisely because their legal rulings and pronouncements are
authoritative. Moreover, the call to violence at some point in the future when Shari’ahadherent
Muslims have the logistical opportunity to conduct Jihad is captured by the
Smith Act, as the Court explained when it stated that advocacy is an actual call to
violence whether it advocates violence “immediately or in the future”.203
Second, the Shari’ah authorities are not speaking as advocates to an empty auditorium,
but as jurists who issue normative and instructional commands to the members of their
group – i.e., Shari’ah-adherent Muslims. Further, these Shari’ah authorities are chosen
because the Shari’ah faithful listen and act upon their legal rulings. Thus, the call to
violence is likely to result in violence. Evidence of this direct nexus can be observed in
numerous terrorist and violent events that occur immediately after Shari’ah authorities
issue legal rulings calling for violence. One relatively recent event was the violence over
the publication of cartoons in a Danish paper which satirized Mohammed. The cartoons
had been public for several months and it was not until certain leading Shari’ah
201 367 U.S. 290 (1961).
202 367 U.S. at 297.
203 Id. In Brandenburg v. Ohio, 395 U.S. 444 (1969), in a per curiam decision, the Court held in
striking down a state law criminalizing speech advocating violence that such speech is
constitutionally protected unless it is intended and likely to cause imminent illegal conduct. The
Brandenburg Court understood its decision as concordant with the Smith Act cases cited. The
question of “imminence” will no doubt plague future cases and remain a fact-based inquiry.
Imminence will likely involve not simply the timing of the threat of violence, but also its
seriousness and its likelihood.
5 0
authorities called for a “day of outrage” and “worldwide protest” that protests, violence,
and murder erupted en masse.204
Additionally, to the extent that Shari’ah authorities are employed by a U.S. corporation to
issue legal rulings on Shari’ah and, while serving in that capacity, issue rulings which
include a call to Jihad against the United States, the corporations should not ignore the
threat of criminal exposure. The important case on this point is the Supreme Court’s
decision in New York Central v. United States.205 Federal prosecutors indicted a railroad
company based on the conduct of an assistant traffic manager, who paid illegal rebates.206
While corporations could be liable for breach of civil law duties, prior caselaw had
established there was no criminal liability for corporations because, as artifices of the
law, they could not have the requisite mens rea. The Court, however, took this
opportunity to transport the concept of respondeat superior from tort law and import it
into the criminal law:
Applying the principle governing civil liability, we go only a step farther
in holding that the act of the agent, while exercising the authority
delegated to him to make rates for transportation, may be controlled, in the
interest of public policy, by imputing his act to his employer and imposing
penalties upon the corporation for which he is acting in the premises.
. . .
. . . [W]e see no good reason why corporations may not be held
responsible for and charged with the knowledge and purposes of their
agents, acting within the authority conferred upon them. If it were not so,
many offenses might go unpunished and acts be committed in violation of
law where, as in the present case, the statute requires all persons, corporate
or private, to refrain from certain practices, forbidden in the interest of
public policy.207
In the matter under discussion, legal counsel will be somewhat misguided to argue in
defense of their corporate clients that the Shari’ah authorities were employed strictly to
issue legal rulings on financial matters and all other rulings fall outside the scope of their
employment. Typically, criminal respondeat superior applies where the agent (i)
204 Olivier Guitta, The Cartoon Jihad: The Muslim Brotherhood's project for dominating the
West, WEEKLY STANDARD 22, Feb. 20, 2006, available at
http://www.weeklystandard.com/Content/Public/Articles/000/000/006/704xewyj.asp (last visited
Jan. 31, 2008).
205 212 U.S. 481 (1909).
206 212 U.S. at 498. The Elkins Act made it an offense to “give or receive a rebate whereby goods
are transported in interstate commerce at less than the published rate.” Preet Bharara,
Corporations Cry Uncle and Their Employees Cry Foul: Rethinking Prosecutorial Pressure on
Corporate Defendants, 44 AM. CRIM. L. REV. 53, 61 n.42 (2007) (quoting New York Central, 212
U.S. at 498).
207 212 U.S. at 494.
5 1
committed a crime; (ii) within the scope of employment; and (iii) with intent to benefit
the company.208 Arguably, a crime was committed by advocating violent Jihad against
the U.S. The problem with legal counsel’s defense on the “scope of employment”
element is the fact that Shari’ah authorities have stated time and again that there is no
separation between a ruling on commercial matters and one on Jihad. As illustrated by
the very software “filters” employed in SCF, the legal rulings on prohibited vice
industries are part and parcel of the undivided whole of Shari’ah. This explains the SCF
legal ruling by many Shari’ah authorities that Muslims, including U.S. Muslims, should
not invest in U.S. defense industries, yet these same Shari’ah authorities praise and
obligate Muslim investment in weapons for Muslim nations. In other words, the ruling on
weapons in the context of SCF is part and parcel of the Law of Jihad.209 Finally, by
definition, every legal ruling by a Shari’ah authority is for the achievement of Allah’s
divine law and for the attainment of truth and therefore of benefit to all Muslims,
including the companies in which they invest.
While it is not necessarily the case that an aberrant ruling by an “extremist” Shari’ah
authority will always be imputed to his employer, it is not a stretch to conclude that a
company employs a Shari’ah authority precisely because his legal rulings are
authoritative and because Shari’ah is a holistic and integrated legal and normative unit.210
Thus, a ruling on Jihad by a Shari’ah authority is no less a part of his role as an
internationally renowned Shari’ah authority and his employment as such than his other
rulings on SCF.
V. The Exogenous Elements of SCF: Disclosure, Due Diligence, and Other
Compliance Issues
Beyond the duty of disclosure of endogenous elements of Shari’ah -- facts which would
be material to a reasonable investor who has been told of an investment or business
transaction represented to be Shari’ah-compliant -- several other legal issues arise in the
context of how SCF is actually structured. Thus, beyond the question of what must be
disclosed about Shari’ah itself, the “rules and principles” of Shari’ah have been fitted to
modern finance and business to achieve a product that is represented as Shari’ahcompliant.
These contemporary structures are exogenous to Shari’ah but very much a
part of how Shari’ah has been manipulated to accommodate modern finance and
commerce. These exogenous elements reflect on how Shari’ah has been transformed,
modeled, and presented in various SCF contexts.
It is important to keep in mind a fundamental principle of SCF and a corollary of that
principle. The principle is that Shari’ah compliance must be judged by one or more
208 W. PAGE KEETON, PROSSER AND KEETON ON TORTS 499-508 (5th ed. 1984). For a general
discussion on corporate liability, see Note, Corporate Crime: Regulating Corporate Behavior
through Criminal Sanctions, 92 HARV. L. REV. 1227, 1247-51 (1979).
209 In his essay on the proper role of a Shari’ah authority for a mutual fund, DeLorenzo argues
that beyond the “quantitative” rules, there are “socially responsible” screens that must be applied
over the purely objective ones. DeLorenzo, supra note 22, at 6.
210 See infra notes 245-250 and accompanying text.
5 2
Shari’ah authorities. It is clear from the literature that a non-Muslim cannot determine
what is Shari’ah-compliant and further that a Muslim who is not recognized by his peers
as a Shari’ah authority cannot assume the role of one. The corollary of this principle is
that the Shari’ah authorities are themselves bound by the community of Shari’ah
authorities within which they operate. The exact nature of this community or
“consensus”, both in terms of its theoretical elasticity and its geographic boundaries, is
only vaguely articulated in the SCF literature, but the implications of its contours both
when adhered to and when breached are significant.
A. Disclosure
Our analysis begins with an examination of several questions about what it means to
represent to the public that a financial institution or business has embraced SCF. Is there
a duty to represent to the public what a Shari’ah authority is and how any given authority
has obtained that status? Is it material to the investment? Is the failure to articulate the
risks associated with conflicting SCF rulings from a more authoritative Shari’ah
authority a disregard of minimal standards of disclosure?211
Moreover, is there a duty to disclose to the public whether the Shari’ah authorities
chosen by a U.S. financial institution have issued authoritative rulings on matters that
would implicate discrimination or violence against non-Muslims and non-Shari’ahcompliant
Muslims? Is it important that a financial institution’s Shari’ah authority relies
on the Shari’ah rulings of authorities who have called for a worldwide Islamic Caliphate
ruled by Shari’ah? Further, when the Shari’ah authorities rule that investment in a
military or weapons industry are forbidden by Shari’ah, is it important for the U.S.
financial institution to disclose to the reasonable post-9/11 investor whether there is such
a Shari’ah ban on investments by Muslims in Muslim military industries for weapons to
be sold to Muslim regimes?
In this context, the Nike case discussed above takes on a new dimension. Recall that
Nike, an Oregon corporation, was sued in California under its Unfair Competition Law
on the grounds that Nike’s public statements in defense of its labor practices abroad were
actionable.212 The California Supreme Court was not inclined to restrict the statute’s
reach and rejected Nike’s argument that its free speech rights were violated. Nike had
argued that the extension of such business fraud statutes to generic discussions by
companies that have more to do with social commentary on issues of public importance
than promoting the sale of specific goods and services is to effectively deny First
Amendment protections to U.S. businesses. In effect, after being attacked in the media
and having chosen to speak in its own defense, Nike had invited the lawsuit under
California’s Draconian consumer fraud statute. The company could have continued to
211 It seems Shari’ah authorities themselves understand the reputational and even financial risks
of not imposing some broad standards for entry into the elite group of Shari’ah authorities and for
not standardizing what is Shari’ah-compliant and what is not. See, e.g., IFSB Standards, supra
note 127.
212 Nike, Inc. v. Kasky, 539 U.S. 654 (2003); see also supra notes 140-142 and accompanying
text.
5 3
litigate the case for years, attempting to prove that it had spoken truthfully about its
offshore labor practices, but it understood that every new twist and turn in the litigation
would amount to millions of dollars in bad publicity for a company that spent millions
trying to build and maintain its brand.
Nike’s experience raises the following question for proponents of SCF: When U.S.
companies tout SCF as “ethical” and “socially responsible investing” or as simply
innocuous “interest-free” and “vice-free” investing, does this amount to consumer fraud?
In California at least, the groundwork for an affirmative finding has been prepared.
Another exogenous factor has been addressed by the academic and professional SCF
literature. A significant focus of SCF publications is the dearth of competent Shari’ah
authorities worldwide. This is due to the fact that, while Shari’ah authorities are available
in sufficient numbers to answer the needs of the Shari’ah-adherent communities
worldwide213, there is a severe shortage of these authorities who are sufficiently versed in
English and modern finance to handle the international documentation invariably drafted
with an eye towards institutions working out of London or New York. Because there are
only approximately 20-25 sufficiently trained Shari’ah authorities, each of these
exclusive club members sits on dozens of the Shari’ah supervisory boards around the
world. The result is a small clique that advises the lion’s share of competing financial
institutions on how to develop new SCF products and transaction structures.214
The legal advisor must evaluate the disclosure issues given the fact that a Shari’ah
authority’s rulings and artful craftsmanship in finding new transactional structures to
avoid Shari’ah prohibitions might very well differ from one institutional client to another
given the relative financial remuneration. Furthermore, are there issues that ought to be
disclosed to a reasonable investor relating to confidentiality and the systems put in place
to protect confidentiality? What duty of care do the Shari’ah authorities owe the financial
institutions? Are they considered experts for purposes of the 1933 Act? Do they
participate in writing the portions of the registration statement or prospectus that deal
with Shari’ah?
In all of these areas, the materiality and scienter issues discussed above will play into the
calculus for the legal advisor as the examination of these and other exogenous elements
unfold. An additional facet of the disclosure complex, especially as it relates to the
scienter standard of recklessness, is the implication for the financial institutions and their
213 This is assisted by the burgeoning use of Internet sites which provide legal rulings (fatawa) to
the Shari’ah faithful anywhere in the world. See, e.g., IslamOnLine.net,
http://www.islamonline.net/english/index.shtml (last visited Jan. 31, 2008).
214 Alexiev, supra note 18, at n.43. The number 20-25 was derived by developing a list of names
of Shari’ah authorities which appear in SEC filings and the major SCF Internet sites. If one
includes Shari’ah authorities who deal almost exclusively in Pakistan, Malaysia, or the GCC
states, the number is probably closer to 60. See generally Islamic Banking and Finance Issue #3
Summary, http://islamicbankingandfinance.com/summary3.html (last visited Jan. 31, 2008)
(summarizing an issue of the London-based journal Islamic Banking and Finance, which
discusses this “bottleneck”).
5 4
professional advisors of a duty to conduct due diligence to make certain that what they
have said about SCF is the whole of the material truth.
B. Due diligence
The articulation of a breach of duty to disclose is closely related to the duty to exercise
reasonable due diligence as either an element of scienter or a defense where scienter is
not at issue. For example, under the 1933 Act, Sections 11 and 12(a)(2) provide for a due
diligence defense for certain defendants who have failed to disclose all relevant material
facts.215 The caselaw and literature on these defenses is extensive, and legal counsel for
any financial institution will have to seriously consider the implications of ignoring the
exogenous structures set up for a Shari’ah-compliant investment or business. At the very
least, each of the exogenous disclosure issues should be the subject of a carefully
prepared legal opinion. Failure to rely on an expert legal opinion will likely expose the
financial institution and its management to greater liability insofar as failure to do so rises
to the level of reckless breach of the duty of care. The duty to rely on a formal legal
opinion intimates the lawyer’s exposure to liability for failure to conduct a reasonably
competent investigation.
C. Other compliance issues
1. Global security risks revisited
The due diligence requirements implied in the scienter element of many fraud actions and
provided expressly as defenses under securities laws are only one component of the due
diligence analysis pertinent to SCF. In the main, the effort to combat the global security
risks associated with Islamic terror networks and the regimes which support those
networks has incorporated many strategies, only some of which are appropriately suited
to the task at hand. One approach is through trade sanctions and embargoes. These
foreign policy initiatives are authorized by such laws as the Trading with the Enemy Act
(“TWEA”)216 and the International Emergency Economic Powers Act (“IEEPA”),217
which authorize the Office of Foreign Assets Control (“OFAC”) of the Treasury
Department to establish sanction regimes on states identified by the President as falling
within the jurisdictional reach of either of the two laws.218
The Halliburton affair described above, which began as a seemingly innocuous inquiry
by the New York City Comptroller on behalf of some shareholders into disclosure
requirements of an annual proxy statement, soon spiraled out of control. After
Halliburton was forced to report to its shareholders on the financial and reputational risks
of doing business in a terror-sponsoring state, the Comptroller was still unsatisfied and
considered the company’s disclosures inadequate. Soon thereafter, OFAC got involved
215 See supra notes 176-178 and accompanying text.
216 50 U.S.C. app. § 1 (2007).
217 50 U.S.C.S. §§ 1701-1706 (2007).
218 See, e.g., Notice of March 8, 2007--Continuation of the National Emergency With Respect to
Iran, 72 Fed. Reg. 47 (March 12, 2007).
5 5
and referred the matter to the DOJ, which initiated a grand jury investigation.219 Other
companies doing business in terror-sponsoring states have also run into trouble.220 While
the implications for financial institutions relying on Shari’ah authorities associated with
or sympathetic to terrorists do not touch upon TWEA or IEEPA compliance per se, the
duty of disclosure of material facts under the compliance regimes remains.
a. Reverse money laundering revisited
Another approach to the global security risk of Islamic terrorism has been through the
strengthening of anti-money laundering laws and regulations. The “heavy lifting” of this
effort of late has been accomplished by the Patriot Act and its amendments to the Bank
Secrecy Act (“BSA”)221 and the anti-money laundering statutes.222 But with all of the
fanfare and political disputation surrounding this legislation by civil libertarians, civil
rights activists, and various Muslim organizations,223 the latter of which have argued that
219 See HALLIBURTON COMPANY, FORM 10K FOR THE FISCAL YEAR ENDED DEC. 31, 2006, at 58,
available at
http://www.sec.gov/Archives/edgar/data/45012/000004501207000072/ed10k2006_final.htm (last
visited Jan. 31, 2008):
Operations in Iran
We received and responded to an inquiry in mid-2001 from the Office of Foreign
Assets Control (OFAC) of the United States Treasury Department with respect to
operations in Iran by a Halliburton subsidiary incorporated in the Cayman Islands. The
OFAC inquiry requested information with respect to compliance with the Iranian
Transaction Regulations. These regulations prohibit United States citizens, including
United States corporations and other United States business organizations, from engaging
in commercial, financial, or trade transactions with Iran, unless authorized by OFAC or
exempted by statute. Our 2001 written response to OFAC stated that we believed that we
were in compliance with applicable sanction regulations. In the first quarter of 2004, we
responded to a follow-up letter from OFAC requesting additional information. We
understand this matter has now been referred by OFAC to the DOJ. In July 2004, we
received a grand jury subpoena from an Assistant United States District Attorney
requesting the production of documents. We are cooperating with the government’s
investigation and responded to the subpoena by producing documents in September 2004.
Separate from the OFAC inquiry, we completed a study in 2003 of our activities in
Iran during 2002 and 2003 and concluded that these activities were in compliance with
applicable sanction regulations. These sanction regulations require isolation of entities
that conduct activities in Iran from contact with United States citizens or managers of
United States companies. Notwithstanding our conclusions that our activities in Iran were
not in violation of United States laws and regulations, we announced that, after fulfilling
our current contractual obligations within Iran, we intend to cease operations within that
country and withdraw from further activities there.
220 See Lau, supra note 164, at 418-19.
221 31 U.S.C. §§ 5318 et seq. (2006).
222 See generally Eric J. Gouvin, Bringing Out the Big Guns: The USA Patriot Act, Money
Laundering, and the War on Terrorism, 55 BAYLOR L. REV. 955 (2003).
223 See, e.g., CairChicago.org, Action Alert (Dec. 1, 2005), available at
http://www.cairchicago.org/actionalerts.php?file=aa_blog12012005 (last visited Jan. 31, 2008)
5 6
the government’s effort is unduly focused on Islamic terrorism, the legislation still fails to
grapple effectively with the problem of money laundering in support of terrorism. Almost
all of the BSA and the regulations promulgated thereunder and the anti-money laundering
statutes approach the problem of terrorist financing in the traditional way,
notwithstanding a dangerous new modus operandi. The BSA and anti-money laundering
statutes are intensely focused on spotting and reporting suspicious money transfers,
especially cash transfers, which have criminal sources.224
This approach to battling the funding of terrorism fits the traditional approach to antimoney
laundering efforts, which looks for money from illegal activities such as drugs and
gambling, typically in the form of cash, and its laundering into clean money invested in
legitimate businesses. As long as the effort is “following the money” in the form of cash
from its entry in the regulated and reporting financial system (what the experts call
“placement”)225 as it winds its way to its ultimate destination, the system works at least
moderately well, although most experts will admit that it both misses large sums and
suffers from over-reporting of perfectly legitimate cash transactions.226 Much of
contemporary terror financing, however, is conducted through what has been termed
“reverse money laundering”.
Reverse money laundering stands the classic model on its head---perfectly legitimate
funds are wired or transferred to U.S. domestic charities and organizations and then to
overseas charities and organizations, or sometimes just directly overseas. These
transactions are difficult to spot unless government regulators already have the specific
charities and organizations in question under surveillance.227 Such proactive or
prophylactic surveillance runs into privacy and constitutional thickets. Assuming the
federal government does not have sufficient evidence for a probable cause or FISA
warrant228, targeting Muslim charities would be roundly protested as racial profiling
irrespective of the actual legal or constitutional infirmities of the practice.229 As a result,
(announcing a special Internet web log site opposing the Patriot Act on “civil rights” grounds,
published by the Council on American-Islamic Relations (CAIR)).
224 See Gouvin, supra note 222, at 976-77.
225 FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNSEL, BANK SECRECY ACT/ ANTIMONEY
LAUNDERING EXAMINATION MANUAL 8 (2006), available at
http://www.ffiec.gov/pdf/bsa_aml_examination_manual2006.pdf (last visited Jan. 31, 2008).
226 See Gouvin, supra note 222, at 967-69.
227 Id. at 976-77.
228 “FISA” is the Foreign Intelligence Surveillance Act of 1978, Pub. L. No. 95- 511, 92 Stat.
1783 (codified as amended at 50 U.S.C. §§ 1801-1862), which was amended materially by the
Patriot Act. See USA Patriot Act, § 218, 115 Stat. 291 (amending 50 U.S.C. §§ 1804(a)(7)(B) &
1823(a)(7)(B)). A Fifth Amendment “criminal” warrant typically requires a showing of probable
cause before a judge. The FISA requirements for a warrant, which are directed at foreign threats,
even if on domestic soil, has relaxed standards. For a thorough explanation of these standards, see
Richard Henry Seamon & William Dylan Gardner, The Patriot Act and the Wall Between
Foreign Intelligence and Law Enforcement, 28 HARV. J.L. & PUB. POL’Y 319 (2005).
229 See David Hardin, The Fuss Over Two Small Words: The Unconstitutionality of the USA
PATRIOT Act Amendments to FISA Under the Fourth Amendment, 71 GEO. WASH. L. REV. 291,
291 & n.395 (2003).
5 7
while administrative “blocking orders” promulgated under the authority of the IEEPA
have been an effective tool in disrupting and shutting down some of the largest and most
dangerous Muslim charities funding terrorism,230 prosecutions of terror-financing through
charities have had mixed results.231
This problem raises its ugly head with SCF in two ways. One way, although it does not
yet appear to be the norm in the U.S., is through a charitable contribution made at source
by an SCF financial institution or business. This would occur because faithful Muslims
must gift a certain percentage of their income to charity. It appears that in the Middle
East and Malaysia, SCF companies, banks, and investment funds might actually calculate
the amount the individual Muslim investors owe from profits and distribute those funds
automatically to Islamic Shari’ah-approved charities, and only then would the net, after-
230 See generally Montgomery E. Engel, Donating “Blood Money”: Fundraising For
International Terrorism By United States Charities and the Government's Efforts to Constrict the
Flow, 12 CARDOZO J. INT'L & COMP. L. 251 (2004). Specifically, Engel writes that:
The authority of the President to issue both Executive Orders 12,947 and 13,224
originates in the International Emergency Economic Powers Act (“IEEPA”). Upon
declaration of a national emergency in response to an “unusual and extraordinary threat,”
IEEPA grants the President broad authority to govern the disposition and block the assets
of “any person, or with respect to any property, subject to the jurisdiction of the United
States.” The Supreme Court has upheld IEEPA's broad grant of authority to the President
in its form as amended in 1977. The Court refused to limit the President’s authority to
continued blocking or freezing but ensured that it extended to the permanent disposition
of assets suggested by IEEPA’s congressional grant of the power to “transfer,” “compel,”
and even “nullify” assets. Underlying this deferential grant, the Court recognized a
legitimate and discretionary exercise of the President’s power to govern foreign policy by
using frozen assets as a "bargaining chip" in dealing with a hostile country.
Id. at 258-59 (footnotes omitted). The role of Muslim charities in financing terror has been
discussed in Congressional testimony as well. See Role of Charities and NGOs in the Financing
of Terrorist Activities: Hearing Before the Subcomm. on International Trade and Finance of the
S. Comm. on Banking, Housing, and Urban Affairs, 107th Cong. (2002) (statement of Matthew
Levitt, Senior Fellow, Washington Institute for Near East Policy), available at
http://banking.senate.gov/02_08hrg/080102/levitt.htm (last visited Feb. 1, 2008). Military
strategists have also looked at this modality for furthering the terrorist war aims. See Major
Wesley J. L. Anderson, Disrupting Threat Finances: Utilization of Financial Information to
Disrupt Terrorist Organizations in the Twenty-First Century (November 4, 2007) (unpublished
thesis, School of Advanced Military Studies, U.S. Army Command and General Staff College),
available at http://stinet.dtic.mil/cgibin/
GetTRDoc?AD=A470454&Location=U2&doc=GetTRDoc.pdf (last visited Feb. 1, 2008).
231 Prosecutions for the “material support of terrorism” are notoriously difficult cases to try before
a jury because they often require reams of financial data evidence, circumstantial evidence of
associational links, and the defense often raised by defendants that they had no specific
knowledge that the money they contributed was going to support illegal activities. A recent case
with these dynamics, the largest federal terror-financing case to date, ended in mistrial on the
bulk of the charges. See the court filings (organized and with commentary) in the criminal
prosecution U.S. v. Holy Land Foundation for Relief and Development, Criminal Action No.
3:04-CR-240-G, 2007 U.S. Dist. LEXIS 50239 (N.D. Tex. July 11, 2007), available at
http://www.nefafoundation.org/hlfdocs.html (last visited Jan. 31, 2008).
5 8
Shari’ah-charitable-tax profits be distributed to the individual investor. In the U.S.,
although many of the reporting companies and mutual funds involved in SCF are unclear
about this service, most appear to allow the individual investor to calculate and make her
own charitable contribution.232
Several questions arise for those SCF businesses and investments which net the returns to
the investor after this charitable payment: Which charities are Shari’ah-compliant? Who
makes this determination? Do the businesses or financial institutions direct these
contributions, or are these decisions made by the Shari’ah authorities? Is there any
vetting of the recipients of these charities to determine what they do with these funds?
Why is this process not transparent?
A second form of this problem arises when some of the gross income of a business is
from Shari’ah-prohibited sources. This typically occurs in two ways. The first is via the
exceptional event when a Shari’ah “filter” misses a tainted source of income altogether.
This might happen when a Shari’ah-compliant company in a Shari’ah-compliant mutual
fund acquires a forbidden company, the main business of which is in a forbidden industry
such as finance or hog farming. Assuming the acquired company’s forbidden assets are
not de minimis, the acquisition renders the parent company in the mutual fund’s portfolio
Shari’ah-prohibited and the equity position in that company must be sold. The proceeds
of that sale will include a certain amount of profits attributed to the forbidden assets. That
amount must be calculated and “purified”.233
The second occasion for purification is more typical. For example, a mutual fund is
permitted to invest routinely in companies which earn up to a fixed percentage of their
income from interest. Notwithstanding this leniency, any profits to the mutual fund
attributed from this forbidden income must be “purified” at some point.234
Because the calculation of this purification can be complex, most Shari’ah authorities
either insist or prefer that the purification take place by the SCF institution so the
Shari’ah authorities will have the opportunity to assess the amount needed to be purified
and supervise the logistics.235
232 One of the leading Shari’ah authorities recommends that Shari’ah-compliant mutual funds
calculate the Shari’ah-based religious tax called zakat for the investors and withhold it at source
as a value added. See generally supra note 22 and accompanying text. The assumption for this
memorandum has been that if a reporting mutual fund does not disclose that it has the authority to
gift zakat contributions on behalf of the individual investors, then the mutual fund has left that for
the individual investors.
233 Id.; see also Yaquby, supra note 39; ISLAMIC FINANCIAL SERVICES BOARD, EXPOSURE
DRAFT: GUIDING PRINCIPLES ON GOVERNANCE FOR ISLAMIC COLLECTIVE INVESTMENT
SCHEMES 14-17 (Dec. 2007), available at
http://www.ifsb.org/view.php?ch=4&pg=140&ac=31&fname=file&dbIndex=0&ex=1201805784
&md=%EB%FA%AF%F7%DD%E3%80%1F%9C%DC%ED%9F%07%EE%E7%23 (last
visited Jan. 31, 2008).
234 See supra note 230.
235 Id.
59
As in the charitable contribution discussion, the purification process typically is not fully
disclosed in public filings of U.S. SCF financial institutions. The questions raised above
about disclosure for the general charitable tax apply here mutatis mutandis. But since
most Shari’ah authorities have ruled that it is more appropriate to have the purification
process carried out by the SCF company rather than by the individual investor, one might
reasonably assume that this is the general rule.236
In both instances, the legal advisor to the SCF financial institution or business must be
careful about how these charitable contributions are made and who the beneficiaries of
these funds are. Given the history of Islamic charities funneling contributions to terrorist
organizations directly and indirectly through other charitable organizations in a
laundering process, the anti-money laundering laws must be analyzed carefully by the
attorney to be certain that the financial institution is not facilitating a criminal violation
and that there is strict compliance with all reporting requirements.
The principal anti-money laundering statutes are Title 18, Sections 1956 and 1957. As
indicated above, the focus of these statutes is on criminalizing the movement of funds
from unlawful activity. As such, they have a limited application to the issue of charitable
contributions directed by Shari’ah authorities related to a given SCF financial institution.
The legal advisor, however, must take the following into consideration in proffering his
advice. Section 1956(a)(2) criminalizes the following:
(2) Whoever transports, transmits, or transfers, or attempts to transport,
transmit, or transfer a monetary instrument or funds from a place in the
United States to or through a place outside the United States or to a place
in the United States from or through a place outside the United States—
(A) with the intent to promote the carrying on of specified
unlawful activity; . . ..237
Two issues stand out. One, a purely domestic transfer of legal funds with the requisite
criminal intent is not a per se violation. Arguably, if a domestic transfer took place but
with the understanding that the funds would find their way overseas as part of the
criminal intent, such a transfer would be prohibited. Thus, a U.S. financial institution
might run afoul of this provision when it “purifies” its forbidden assets by transferring
236 While it does not appear that the DJII calculates the “purification” requirement for its index of
funds with a concomitant reduction in the stated values and returns for its universe of stocks, one
index actually promotes this feature:
Incorporates Dividend Purification: In addition, the application of a dividend
adjustment factor in the creation of the MSCI Islamic Index Series results in more
relevant benchmarks, as they reflect the total return to an Islamic portfolio net of
dividend purification.
MSCI Global Islamic Indices, http://www.mscibarra.com/products/indices/islamic/ (last visited
Jan. 31, 2008).
237 18 U.S.C. §1956(a)(2)(A) (2006).
6 0
funds to a terrorist-supporting charity overseas or possibly even to a domestic charity as a
conduit to problematic overseas groups.
The second issue is intent. The statute requires that the defendant have the intent to move
the funds to promote one of the illegal activities enumerated. Terrorism is one of those
criminal activities set out in Section 1956(c)(7). A lawyer representing a financial
institution contemplating “purification” must consider the possibility that the charitable
gift might be going to a charity with intimate connections to terrorists.238 In this context,
prudent legal counsel must determine who directs the funds to the charitable contribution,
whether the charities or universe of acceptable charities are chosen by the Shari’ah
authorities, and whether this decision is binding on the financial institution. The issue
here is obvious. If the financial institution places this decision-making authority into the
hands of the Shari’ah authorities it has retained, it is possible that any criminal “intent” or
“purposes” connecting the Shari’ah authorities to these charities will be attributed to the
financial institution. The criminal culpability in this case is similar to that described
above in the discussion of the Smith Act.
While many financial institutions involved in SCF attempt to distance themselves from
the Shari’ah authorities, a lawyer analyzing these issues must determine who made the
decision about which charities would be considered Shari’ah-complaint and thus
recipients for the “purification” of funds. Moreover, if it turns out that these charities
have ties to terrorists or are implicated in the material support of terrorism, the lawyer
must determine whether this fact was known to any agent of the company.239
Obviously, the criminal exposure arising from the “purification” process might lead
responsible legal counsel to ask the following questions about any list of potential
charities: Are these well-known non-Muslim charities? If they are Muslim charities, have
they been vetted and by whom? The three largest Muslim charities in the U.S. have all
been implicated in financing terror and subject to administrative blocking orders wherein
their assets were frozen and they were effectively shut down.240
238 As one commentator began an analysis into the problem of Muslim charities being used to
funnel funds to Islamic terrorists:
On December 4, 2001, nearly three months after the terrorist attacks of September
11th and barely three days after a pair of terrorist suicide bombings killed 25 and injured
200 in Israel, President Bush declared the Holy Land Foundation for Relief and
Development (“HLF”) of Richardson, Texas, a terrorist organization, its assets frozen,
and announced that its offices had been raided by the FBI. Purportedly the largest
Muslim charity in the United States, HLF had been under investigation by the FBI for its
alleged financing of the Islamic Resistance movement, or Hamas, for nine years. Ten
days later, the Bush Administration acted again, freezing the assets and raiding the
offices of two more Muslim charities, the Benevolence International Foundation (“BIF”)
and the Global Relief Foundation (“GRF”), both located in the Chicago, Illinois area.
Engel, supra note 230, at 251 (footnotes omitted).
239 Or, as set out supra note 184 and accompanying text, was this fact willfully or recklessly
avoided?
240 See supra note 238.
6 1
The practice of Muslim charities funneling money to terrorists is so widespread and the
problem so insidious that the federal government keeps an updated list on the dozens of
such organizations worldwide.241 But it will not suffice for the legal advisor to simply
determine that the charities are “well-known” Muslim charities and not currently listed as
designated supporters of terrorism. At a minimum, the following queries would need to
be undertaken: Who are the ultimate beneficiaries of the contributions? (In other words,
who or what is the ultimate recipient of the charities’ “good deeds”?) Do these charities
have overseas branches? Is the financial institution wiring the funds domestically or
internationally? Who or what organization founded the organizations and who controls
them today?
Once these questions are answered, the legal advisor will need to be careful that,
whatever policies are put in place to avoid criminal exposure under Sections 1956 and
1957, the client continues to monitor these “charitable contributions” carefully.242
b. Material support of terrorism and related civil exposure
Material support of terrorism is a federal crime under 18 U.S.C. §§2339 (A) and (B). The
Intelligence Reform and Terrorism Prevention Act of 2004243 amended the definition of
“material support” to read as follows:
(1) the term “material support or resources” means any property, tangible
or intangible, or service, including currency or monetary instruments or
financial securities, financial services, lodging, training, expert advice or
assistance, safehouses, false documentation or identification,
communications equipment, facilities, weapons, lethal substances,
explosives, personnel (one or more individuals who may be or include
oneself), and transportation, except medicine or religious materials.244
A Shari’ah authority issuing, promoting, or advocating a legal ruling for Jihad to anyone
for the purpose of conducting terrorism would clearly fall within the definition of “expert
advice” “derived from . . . specialized knowledge”. In addition, a New York federal
district court found that an attorney who passed along a legal ruling calling for Jihad had
provided “material support” in the form of “personnel” as part of a terror-laden
conspiracy. In U.S. v. Satter245, the court upheld attorney Lynne Stewart’s conviction for
violating Section 2339(A) by merely passing along a fatwa or legal ruling regarding
Jihad issued by her client, Sheikh Omar Abdel Rahman, to terrorists in Egypt who
241 See U.S. Department of the Treasury, Key Issues: Protecting Charitable Organizations,
http://www.ustreas.gov/offices/enforcement/key-issues/protecting/charities_execorder_13224-
a.shtml#a (last visited Jan. 31, 2008).
242 Typically, good legal counsel, when developing a due diligence plan, will construct it such that
it accounts for the threshold prima facie requirements of an indictment or other criminal charging
process rather than an acquittal at trial.
243 108 Pub. L. No. 458, 118 Stat. 3638 (2004).
244 18 U.S.C. § 2339(A)(b) (2006).
245 395 F. Supp. 2d 79 (S.D.N.Y. 2005).
6 2
respected his authority in matters of Shari’ah. The court concluded that passing along a
legal ruling was like providing “personnel” to the co-conspirators and amounted to
material support.246
A U.S. company that promotes the legal rulings of a Shari’ah authority who is known for
issuing such rulings on the Law of Jihad could risk extraordinary criminal exposure.
While it is not likely that the company would promote the actual rulings relative to Jihad
or do so with the intent to cause violence, this will not be the standard. The question will
be what role does the Shari’ah authority occupy within the company or what relationship
does he have to the company if he is an “outside advisor”. To the extent that criminal
respondeat superior implicates the corporate entity in the Shari’ah authority’s scienter, a
defense built upon lack of knowledge by the board of directors will not be effective. And
the fact that such legal rulings are published in broad daylight and available from English
open sources will render the corporation’s plea of lack of intent all the more unavailing to
the extent it rises to the level of “willful blindness” or “recklessness”.
Additional areas of criminal and civil liability exposure relate to the anti-money
laundering statutes. To the extent that any “purification” funds move from the financial
institution to a charity and these funds are found to support the terrorist activities, there is
additional criminal exposure under Sections 2339(A) and (B). Both of these statutes
forbid the provision of material support for terrorism. The distinction between the two
statutes is important. Section 2339(A) requires a showing that the defendant provided
support knowing its intended purposes. Under Section 2339(B), the defendant need only
know of the status of the target organization as a terrorist organization and need not know
or intend that the material support is going to support terrorism.247 The discussion above
regarding corporate criminal exposure for the intent of the company’s agents applies here
as well and must be considered by legal counsel.
In addition to criminal exposure, to the extent that a U.S. financial institution can be
criminally linked to terrorist organizations as a result of the “purification” funds or via
other “material support” relationships between the Shari’ah authorities and the terrorists,
additional statutes provide civil exposure to victims of such violence, even if the violence
occurs outside the jurisdiction of the U.S. The most important of these statutes is Title 18,
Section 2333, which provides for civil remedies and treble damages for any U.S. national
injured by terrorists. Several federal circuits have allowed private rights of action under
this statute against defendants who have “aided and abetted” the offending terrorists by
violating Sections 2339(A) and (B).248
Beyond the civil exposure in Section 2333, the Alien Tort Statute (“ATS”)249 probably
exposes companies linked criminally to terrorism to enormous civil liability. It is bad
enough to be sued by U.S. nationals for damages caused by terrorism, but the potential
246 Id. at 99.
247 For the discussion of this point in an earlier appeal arising out of the same trial, see U.S. v.
Sattar, 314 F. Supp. 2d 279, 301-02 (S.D.N.Y. 2004).
248 See, e.g., Boim v. Quranic Literacy Inst., 291 F.3d 1000 (7th Cir. 2002).
249 28 U.S.C. § 1350 (2006).
6 3
for mass litigation by foreigners for such damages is much worse. Once the criminal
connection is made through the anti-money laundering or the material support of
terrorism statutes, the plaintiffs’ bar will then allege that terrorism is a violation of some
norm of the law of nations that is “specific, universal, and obligatory” and that there is a
proximate cause between the “material support of terrorism” alleged and the injuries
suffered.250
2. Antitrust
Another area of civil liability exposure related to the exogenous structure imposed by the
need for Shari’ah authority boards arises under antitrust law. As noted above, at present
approximately two dozen Shari’ah authorities monopolize the positions available on the
Shari’ah authority boards of the major Shari’ah-compliant financial institutions
worldwide. There has been a concerted effort among these Shari’ah authorities to impose
universal standards to prevent materially divergent opinions. This effort has been
spearheaded by the Accounting and Auditing Organization for Islamic Financial
Institutions (“AAOIFI”) and the Islamic Financial Services Board (“IFSB”), the former
of which seeks to establish accounting standards for the various transactional structures
and the latter to set the standards by which Shari’ah authorities self-regulate and interact
with the financial institutions that employ them.251
According to the IFSB and the independent writings of many Shari’ah authorities, there
are designs to establish industry-wide minimal credentials a newcomer would be required
to obtain to enter this apparently lucrative consulting business.252 The initial antitrust
issue raised by such efforts is the problem of “group boycotts” or the implications of
“self-regulation” for a small, discreet, and insular group of authorities who have almost
total market share deciding how one gains entry into the market.253 Applying the standard
250 The ATS is a jurisdictional statute. See Sosa v. Alvarez-Machain, 542 U.S. 692 (2004). It gives
an alien plaintiff access to federal courts if there is an allegation that the alien suffered some harm
that is in “violation of the law of nations or a treaty of the United States.” Id. In the Court’s
opinion, it held that the norm of law violated must be “specific, universal, and obligatory.” Id. at
732. The U.S. laws against terrorism and the “material support of terrorism” are in accord with
the Law of Nations and at the very least are “specific, universal, and obligatory.” See, e.g.,
Filartiga v. Pena-Irala, 630 F.2d 876, 885 (2d Cir. 1980) (stating that torture is a violation of the
Law of Nations); see also Torture Victim Protection Act of 1991, § 2(b), Pub. L. No. 102-256,
106 Stat 73 (codified at 28 U.S.C. § 1350).
251 See supra note 15 and accompanying text; see also Islamic Financial Services Board,
http://www.ifsb.org/index.php (last visited Jan. 31, 2008); Accounting and Auditing Organization
for Islamic Financial Institutions, http://www.aaoifi.com/index.shtml (last visited Jan. 31, 2008).
252 IFSB Standards, supra note 127 (footnotes omitted).
253 See generally Northwest Wholesale Stationers, Inc. v. Pacific Stationery & Printing Co., 472
U.S. 284 (1985); see also Robert Pitofsky, Chairman, Fed. Trade Comm’n, Self Regulation and
Antitrust (Feb. 18, 1998), available at http://www.ftc.gov/speeches/pitofsky/self4.shtm (last
visited Jan. 31, 2008); Debra A. Valentine, Gen. Counsel, Fed. Trade Comm’n, Industry Self-
Regulation and Antitrust Enforcement: An Evolving Relationship (May 24, 1998), available at
http://www.ftc.gov/speeches/other/dvisraelspeech.shtm (last visited Jan. 31, 2008).
6 4
“rule of reason”, courts will look to the motivations and anti-competitive effects of such
“industry standards.”254
This is especially problematic in SCF because, should a non-recognized Shari’ah
authority attempt to market his services to the financial institutions seeking Shari’ah
guidance, a ruling by the existing Shari’ah authorities that the newcomer has not satisfied
their credentialing requirements would render the market closed to that newcomer. This
is because financial institutions who market SCF products to the Shari’ah-adherent
consumer are extraordinarily sensitive to the problem that public disputes among the
Shari’ah authorities over what is permitted or prohibited could devastate both the demand
for SCF products generally and render any given SCF product suspect.255
The problem of “self-regulation” would become an issue for the financial institutions if
they play a material part in this effort to control entry into the market by newcomers in a
de jure or de facto collusion with the dominant group.256 Another problem is “rules
collusion”257. Here, the effort by the financial institutions and their agents, the Shari’ah
authorities, to agree upon what transaction structures and investments should be
considered “Shari’ah-compliant” will limit the development of new competitive products
by market players. This, in turn, will make it more difficult for the consumer to
distinguish between SCF products and raise the cost of searching for newer, innovative
SCF products -- thereby shaping and softening competition among cartel members in
order to increase the profits of the parties to the agreement.258 The fact that such a
financial market is predicated upon a consensus of the market’s private rules advisors
suggests that SCF within the financial industry presents substantial exposure to antitrust
liability.
254 Id.
255 See generally McMillen, supra note 9, at 458-67 (attempting to cure the lack of transparency,
certainty, consistency, and predictability of SCF by arguing for the IFSB to propose Model Acts
like the Model Acts propounded by the National Conference of Commissioners on Uniform State
Laws).
256 See Am. Soc'y of Mech. Eng'rs v. Hydrolevel Corp., 456 U.S. 556 (1982). In fact, the SCF
financial institutions participate at various levels in setting the standards for the industry. See,
e.g., AAOIFI Members, http://www.aaoifi.com/members.html (last visited Jan. 31, 2008). The
private banks do not appear to play as significant a role in setting standards for the IFSB. See,
e.g., IFSB Members, http://www.ifsb.org/index.php?ch=3&pg=7&ac=10 (last visited Jan. 31,
2008).
257 For an interesting discussion of “rules collusion” as “Type III,” see Robert H. Lande &
Howard P. Marvel, The Three Types of Collusion: Fixing Prices, Rivals, And Rules, 2000 WIS. L.
REV. 941, 949-84 (2000).
258 Id. The anti-competitive effects of the rule-making monopoly currently enjoyed by the
Shari’ah authorities go in some measure to the endogenous aspects of what Shari’ah itself says
about who is qualified to be part of the Ulema or scholarly elite with any real authority.
Historically and institutionally, because the Shari’ah authorities have used “consensus” and the
limitation of new interpretations via the doctrine of the “closing of the gate of itjima” as a selfregulator,
they have been extraordinarily successful in keeping the group over time true to the
early doctrines developed after the formal schools had articulated them. See, e.g., Coughlin, supra
note 24, passim.
6 5
3. Racketeering
As described above, the leading two dozen Shari’ah authorities effectively establish all of
its rules and regulations. If, in fact, these men have as their ultimate and collective goal
the implementation of a Shari’ah-based Caliphate in the U.S. and their methodologies
include the Law of Jihad---meaning violence when necessary or possible and otherwise
fraud and misrepresentations about the true purpose of Shari’ah---the prima facie case for
a lawsuit under the Racketeer-Influenced and Corrupt Organizations Act (“RICO”) is
almost unavoidable. This is especially true now that the Patriot Act has added the federal
terror-related crimes to the RICO predicate offenses and beefed up the predicate offenses
relating to money laundering.259 A cursory examination of the elements of a viable RICO
prosecution reveals the enormous exposure.
RICO is violated when a defendant, or in this case a cadre of defendants acting as
Shari’ah authorities, engage in a “pattern of racketeering activity” and by having:
(1) Invested income from a pattern of racketeering activity in an “enterprise”;
(2) Acquired or maintained an interest in an “enterprise” through a pattern of
racketeering activity;
(3) Conducted or participated in the affairs of an “enterprise” through a
pattern of racketeering activity; or
(4) Conspired to do any of the above.260
The “pattern of racketeering activity” simply means two or more of the predicate offenses
within a ten-year period.261 Predicate offenses include mail and wire fraud, material
support of terrorism, and money laundering.262 The “enterprise”, which is an entity,
person, or group of entities or persons associated in some de jure way (e.g., partnership)
or as a de facto association, exists separately from the defendants.263 In this scheme, the
enterprise is the financial institution involved in SCF. As discussed above, to the extent
that a U.S. financial institution has criminal culpability for the predicate offenses264, that
particular institution would join the list of defendants and operate as part of the
enterprise. The evidence of the RICO crime then would include the fraud and ulterior
motives of the Shari’ah authorities and how they have manipulated the enterprise to
259 CHARLES DOYLE, CRS REPORT FOR CONGRESS, CRIMINAL MONEY LAUNDERING
LEGISLATION IN THE 109TH CONGRESS (2006), available at
http://www.house.gov/gallegly/issues/crime/crimedocs/RS22400.pdf (last visited Feb. 2, 2008).
260 18 U.S.C. § 1962(a)-(d) (2006); see also NIELS B. SCHAUMANN, GILBERT LAW SUMMARIES:
SECURITIES REGULATION 394 (6th ed. 2002).
261 § 1961(5); see also H.J. Inc. v. Nw. Bell Tel. Co., 492 U.S. 229 (1989) (stating that must show
the predicate acts are related to one another and that they amount to, or constitute a threat of,
continuing racketeering activity).
262 See, e.g., § 1961(1)B & G; see also supra note 259.
263 § 1961(4).
264 See Schofield v. First Commodity Corp., 793 F.2d 28 (1st Cir. 1986) (discussing criminal
respondeat superior under RICO).
6 6
achieve their criminal ends. If such an indictment were handed down, it could lead to a
pretrial asset freeze265 and a post-conviction forfeiture of the criminal enterprise’s
assets.266
4. Banks and consumer loans
Regulated commercial banks and private lenders have recognized the SCF market and
have made significant inroads establishing this new industry. At least one U.S.
commercial bank has attempted to design a Shari’ah-compliant depository account.267
The unique feature of this kind of account is that it must be “at risk” as an equity
investment and not viewed as a guaranteed deposit with interest income. A U.K. bank has
developed a regulatory work-around268, but U.S. regulators have not yet permitted such
accounts, although one community bank in Illinois advertises a Shari’ah-compliant
“profit-sharing deposit account” which purportedly does not earn interest but rather a
share of the bank’s profits. This bank apparently received an exemption from a Shari’ah
authority because the bank guarantees the principal of the deposit, as required by U.S.
banking laws, and such “no risk” guarantees are typically considered forbidden under
Shari’ah.269
Another impediment for commercial banks entering this market appears to have been
overcome. In a typical SCF home mortgage transaction, the lender purchases the property
and either resells it immediately to the borrower at a stepped-up price to be paid out over
time (i.e., a cost-plus sale) or leases it back to the borrower through a sale-lease back
arrangement. The problem for commercial banks in these transactions is that U.S. law
does not allow banks to own real estate except in limited circumstances, such as the
bank’s own offices or property acquired through foreclosures on bad loans.270 Two banks
have received approval from the Office of the Comptroller of Currency (“OCC”) for such
SCF transactions.271 The rationale for the approvals was a substance-over-form analysis.
Since these mortgage products were in fact disguised loans with interest and the real
estate was only owned for a limited purpose, the Comptroller did not see these Shari’ahcompliant
mortgages as a violation of the prohibition against owning real estate. The
265 § 1963(d); see also § 1956(b)(3)-(4).
266 § 1963(a)-(c).
267 See William L. Rutledge, Executive Vice President, [institution], Regulation and Supervision
of Islamic Banking in the United States, Address Before the 2005 Arab Bankers Ass’n of N. Am.
Conference on Islamic Fin.: Players, Products & Innovations in New York City (Apr. 19, 2005),
available at http://www.nubank.com/islamic/regulation.pdf (last visited Jan. 28, 2008).
268 Id.; see also Callum McCarthy, Chairman, FSA Muslim Council of Britain Islamic Fin. and
Trade Conference, Regulation and Islamic Finance (June 13, 2006), available at
http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2006/0613_cm.shtml (last visited
Jan. 31, 2008).
269 See Rutledge, supra note 267.
270 12 U.S.C. § 29 (2006). For a senior officer at the Federal Reserve Bank of New York
remarking favorably on Islamic banking in the United States, see Michael Silva, Islamic Banking
Remarks, 12 AM. LAW & BUS. REV. 201, 201 & n.4 (2006).
271 See supra note 58.
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OCC also granted one of the banks approval to use the cost-plus sale transaction structure
to accommodate construction loans and other consumer loans.272
While the Comptroller was focused on the real estate-banking regulations, one area that
the attorney for any lender must pay special care to address is compliance with all of the
various consumer anti-fraud statutes. The statutes implicated in traditional bank lending
are found in TILA, the Lanham Act, and many of the anti-fraud statutes referenced
above.
Commercial banks and other lenders must comply with TILA273 and its complex
Regulation Z.274 TILA prohibits specific types of misrepresentations or misleading
omissions in advertising.275 It requires lenders to make standardized disclosures
whenever other price terms are advertised. For example, any advertisement that states an
interest rate must state the annual percentage rate (“APR”).276 An oral response to
consumer inquires about closed-end loans, however, may only state the APR.277
Advertisements quoting a down payment by percentage or amount, the amount of any
monthly loan payment or finance charge, the number of payments, or the period of
repayment must also state the APR, the terms of repayment, and the amount or
percentage of any down payment.278
The problem lenders have is that they are marketing the SCF products as interest-free and
therefore Shari’ah-compliant.279 In fact, and as scrutinized by the OCC and likely by the
272 Id.
273 Supra note 114.
274 Supra note 115.
275 For a thorough discussion of the strengths and weaknesses of TILA in regulating misleading
advertising, see Patricia A. McCoy, The Middle-Class Crunch: Rethinking Disclosure in a World
of Risk-Based Pricing, 44 HARV. J. ON LEGIS. 123 (2007).
276 15 U.S.C. § 1664(c) (2006), 12 C.F.R. § 226.24(b) (2005).
277 15 U.S.C. § 1665(a).
278 Id. § 1664(d); Supp. I to Part 226 – Official Staff Interpretations, 12 C.F.R. pt. 226 (construing
§ 226.24(c)), available at http://ecfr.gpoaccess.gov/cgi/t/text/textidx?
c=ecfr&sid=52c796f4a8897e30772fa9be6632dfd5&rgn=div9&view=text&node=12:3.0.1.1.
7.5.8.6.27&idno=12.
279 See, e.g., University Bank, Opening Doors to Islamic Financing, http://www.universitybank.
com/IslamicBanking/homefinance.html (last visited Feb. 1, 2008) (declaring Islamic
Financial Corporation’s loans “free of interest”). While deep in University Bank’s “Frequently
Asked Questions,” http://www.university-bank.com/IslamicBanking/faq.html (last visited Feb. 1,
2008), the bank attempts to explain that “[a]n accountant may argue that rent in the latter two and
profit in the former is interest, but in none of these cases is it riba. Some accountants argue that
anything that may be perceived as generating a benefit from the passage of time has interest in it.
The Sharia’a scholars have not defined riba in this way, rather riba necessarily relates to loans of
money or exchanges of money like commodities when they are used as money.”
Interestingly, in contrast to what one might expect of, an argument aimed at the IRS or OCC -
- which would downplay the “form” and argue that the “substance” of the transaction is a loan --
University Bank represents to its customers that its Shari’ah-compliant transactions are in fact
substantively not loans and that their form is their substance. For example, again buried in its
Frequently Asked Questions:
6 8
IRS and state tax authorities280, these various interest-free transactions are merely
disguised loans. The banks are treating these products and representing them to the
government authorities as conventional loans with interest income while marketing them
to the public as interest-free Shari’ah-compliant non-loan transactions.281
Full disclosure requires these banks to indicate that the loans are not interest-free and to
fully disclose in all of their advertising the true APR. This would require an explanation
that, while a loan might be considered “riba-free” for Shari’ah purposes, it is considered
a standard loan with interest for all secular legal purposes. Unfortunately, even this might
not be true. For example, it is unclear how a bankruptcy court would treat the transaction.
Much would depend on whether the debtor or the lender was in bankruptcy. How the
lender’s attorney navigates these issues in print advertisements and on the Internet will
likely come to a regulator’s or court’s attention.282
An additional concern for Shari’ah-compliant consumer loans is that they are typically
more costly than conventional loans. This is true because of the machinations inherent in
the transactional documents and because much of the documentation must be duplicated
– one set to track Shari’ah compliance and one set to track government regulations. In
addition, Shari’ah supervision adds a cost in most cases as do some extra taxes attributed
to the transfer of title as required by Shari’ah.283 Because these consumer loans are
Query: Isn’t the Islamic system of purchasing houses the same thing, the same
mechanics, as the traditional mortgage system only with different labeling?
SHAPE™: This too is inaccurate. The process of qualifying a consumer and disclosing
costs and risks to a consumer is the same as the mortgage system. This process is
regulated by federal and state statutes in the United States. Hence, the paperwork is the
same or very similar prior to and after making the acquisition, but not the acquisition
itself.
The acquisition mechanics are fundamentally different without creating all of the same
rights and obligations as in a traditional mortgage. Hence, it is not a question of
labeling, but of actual structure.
Id. (emphasis added).
280 See supra note 58.
281 See supra note 279.
282 Bankruptcy and loan defaults open up an entire Pandora’s box of issues that this memorandum
will not and cannot address. Legal commentators have discussed this in passing; however, only in
the most cursory of terms. See, e.g., McMillen, supra note 9.
283 See, e.g., Devon Bank, Frequently Asked Questions,
http://www.devonbank.com/Islamic/faq.html (last visited Feb. 1, 2008):
Why are your costs higher than conventional loans?
To be Shariah-compliant, our costs must be related to our actual expenses. Our products
have a higher documentation fee due to the extra work in product design and assembling
documents for a closing—it is not an automated process as it is for a conventional loan.
Our profit rate is otherwise the same as an equivalent traditional mortgage. There are a
few transaction costs that are higher because of the dictates of the specific deal structure
needed to satisfy the requirements of an Islamic financing transaction, such as two deeds
6 9
marketed to a specific minority community with a unique cultural affinity to Shari’ah,
and because the added costs of these loans have no economic value per se, it is possible
that the marketing of these products will fall within the scope of the anti-predatory loan
laws, such as the Home Ownership and Equity Protection Act ("HOEPA")284 or the state
versions of HOEPA, which are typically more aggressive and have lower thresholds for
offending predatory high-cost loans.285
VI. Conclusion
Shari’ah-compliant finance exposes financial institutions and other businesses to a host
of disclosure, due diligence, and compliance issues, all of which elevate the civil liability
and criminal exposure such companies otherwise factor into their business risk
profiles.286 Preliminary legal analysis indicates that little of this increased civil and
criminal exposure has been recognized, analyzed, or guarded against in any meaningful
way.287 Rather than confronting issues material to a typical post-9/11 investor, lawyers
and accountants have placed SCF in a secular black box, immune from the exacting
scrutiny required of professional advisors in the modern U.S. legal regime. But failure of
companies to diligently investigate their investments, and failure to disclose the risks
caused by these investments, may ultimately result in massive liability to those who
remain willfully ignorant of the realities of the SCF industry.
In pursuing SCF, U.S. businesses face civil liability in the realms of tort law, securities
law, and antitrust. Furthermore, these businesses face criminal exposure in securities,
antitrust, anti-sedition, racketeering, and money-laundering statutes. The failure by
to record instead of one. Otherwise, all our costs are the same as a traditional mortgage.
We do not charge a premium for religious accommodation.
284 Pub. L. No. 103-325, 108 Stat. 2190 (1994) (codified as amended in scattered sections of
TILA, 15 U.S.C. §§ 1601-1667).
285 See generally C. Lincoln Combs, Banking Law and Regulation: Predatory Lending in
Arizona, 38 ARIZ. ST. L.J. 617 (2006).
286 While it has not been the purpose of this memorandum to detail the legal risks for the
professional facilitators, there is substantial legal exposure for the legal, accounting, and financial
professionals who provide the knowledge and expertise to develop the financial and legal
instrumentalities of SCF. While “scheme liability” under a Rule 10b-5 private right of action has
been put to rest by Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 2008 U.S. LEXIS
1091 (U.S. 2008), to the extent that the lawyers get involved in drafting the “representations”,
liability will still apply. See LOSS & SELIGMAN, supra note 5, at 1329-1332 (discussing “primary
liability” for lawyers under Rule 10b-5); id. at 1465-1469 (discussing the “duty to report evidence
of a material violation” under Part 205 to Title 17 of the Code of Federal Regulations
promulgated by the SEC pursuant to Section 307 of the Sarbanes-Oxley Act of 2002).
287 This conclusion has been reached by a thorough review of the published proprietary and nonproprietary
information disseminated by many of the financial institutions and the professional
facilitators (i.e., the law firms, accounting firms, and financial advisors who promote SCF as a
business model and marketing niche) and of the published academic and trade journals which
have treated SCF in some detail over the past decade. Some of this material will be referenced
throughout this memorandum as its relevance to disclosure, due diligence, compliance, industry
standards, and best practices are examined.
7 0
corporate management and their legal advisors to confront these issues in serious fashion
is not surprising given the wholesale failure of the participants and facilitators in this
industry to undertake a serious analysis of the risks. The extant academic and
professional literature reads more like promotional material and not serious legal analysis
conducted by men and women trained to protect clients from their own blind enthusiasm.
The legal industry has gone down this road too many times in the past. This time, the risk
is not simply financial; it is existential. Lawyers, academics, and regulators alike must
acknowledge the potentially dire consequences of Shari’ah-compliant financing and take
steps to address its legal and ethical issues.
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