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Shari’ah’s Black Box: Civil Liability and Criminal Exposure Surrounding Shari’ah-Compliant Finance Print E-mail
Wednesday, 17 September 2008
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.
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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.
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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