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Legal Violations

Legal Violations

Shariah, Law and ‘Financial Jihad’: How Should America Respond? Rep. Chicago: The McCormick Foundation, 2008. pp. 43-45.

The Criminal and Civil Liabilities Associated with Shariah-Compliant Finance

Until recently, no focused effort has been made to identify and analyze the implications for civil liability and criminal exposure for U.S. financial institutions and other businesses engaged in Shariah-Compliant Finance (SCF). Instead, the financial industry has heard almost exclusively from interested parties—particularly law firms, accountants and other SCF specialists—who have been uncritical cheerleaders for this new market.

All too often, such legal or accounting professionals serve as facilitators— driven by complex legal- or accounting-intensive tasks, and further motivated by exorbitant professional fees and the desire to develop a specialized expertise for yet-further marketing of services—while losing sight of the threshold issues for any new and novel market transaction: Does the transaction or business model comply with existing civil and criminal statutory and regulatory frameworks? Does the transaction expose the client to unique and elevated civil liability and criminal exposure or regulatory intervention?

The Conference analysis was drawn in large part from a legal analysis by David Yerushalmi that will be published in the Utah Law Review in September, 2008. Selections from this legal analysis were provided to the conference participants and formed the core of discussions on tactics and strategies for opposing Shariah-compliant finance. This chapter draws almost exclusively from that analysis.

On close examination, it is clear that Shariah-compliant finance does indeed expose the financial institutions and other businesses involved in this industry to a whole host of disclosure, due diligence, and compliance issues—all of which elevate substantially the civil liability and criminal exposure such companies otherwise factor into their business risk profiles. To date, however, very little of this increased civil and criminal exposure has been recognized or analyzed—let alone been guarded against—in any meaningful way.

The following are among the factors that give rise to significant and problematic exposure on civil and criminal grounds for those engaged in Shariah-compliant finance:

  • The Shariah “black box” syndrome: U.S. financial institutions and businesses involved in SCF risk grave consequences by willfully disregarding what Shariah 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.
  • Putting Shariah 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 Shariah: its purposes and its ultimate methods.
  • Undoubtedly, a reasonable post-9/11 investor contemplating an SCF investment would consider (a) the purpose of Shariah (i.e., establishing Shariah as the law of a worldwide hegemony) and (b) the methods of Shariah (i.e., including Jihad) to establish this goal material to the investment decision.
  • To the extent that U.S. Shariah authorities or foreign Shariah authorities retained by U.S. businesses advocate the implementation of traditional and authoritative Shariah, they risk being charged with a violation of 18 U.S.C. § 2385.
  • U.S. financial institutions and businesses have a duty to conduct reasonable due diligence investigations to be certain that their respective Shariah authorities are neither advocating crimes in the name of Shariah 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 might very well lead to civil liability, if not criminal exposure.
  • The Shariah black box is yet another financial fad, like the sub-prime market, where transparency is sacrificed in the mad rush to marketshare and quick profits. U.S. mutual funds are poised to embrace SCF without a word about the risks associated specifically with Shariah. U.S. banks are cavalierly promoting Shariah-compliant loans as “interestfree,” when in fact they are merely repackaged loans at standard interest rates. This violates any number of consumer protection statutes.
  • Financial institutions are underwriting Shariah-compliant loans and bond issuances without really understanding the risks associated with default and bankruptcy treatment.
  • Insofar as U.S. financial institutions participate in and cooperate with the Shariah authorities’ efforts to establish the rules and regulations for the SCF industry, antitrust issues such as rules collusion are likely to present still-more issues of exposure for those embracing this new industry.
  • The current structure of the SCF industry in which roughly several dozen of the most influential Shariah 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 that any aggressive prosecutor or plaintiff’s lawyer looks for in a RICO cause of action.

The failure by corporate management and their legal advisors to confront these issues in any serious fashion is not surprising, given—until now—the wholesale failure of the participants and facilitators in this industry to undertake a serious analysis of these risks. Indeed, the legal academic and professional literature reads more like promotional material than serious legal analysis conducted by men and women trained to protect clients from their own blind enthusiasm. The legal industry has gone down this road too many times in the past. The difference this time is that the risk is not simply financial; it is potentially existential.

The following sections offer an overview of the details on the nature of the civil and criminal exposure believed to be associated with Shariah-compliant finance.

Shariah, Law and ‘Financial Jihad’: How Should America Respond? Rep. Chicago: The McCormick Foundation, 2008. pp. 46-50.

Does Lack of Disclosure Constitute Fraud?

State and federal securities laws, and common law, and state consumer anti-fraud laws, all require disclosure of facts that are material to a post-9/11 investor. The nature of Shariah itself, particularly the requirement for aggressive jihad, is material to investors. The associations, fatwas and writings of the Shariah advisors are material to these investors. The possible disbursement of charitable Zakat funds and “purified” funds to terrorist and jihadist groups is material. Yet none of these topics is disclosed by Shariah-Compliant businesses to their post-9/11 investors. This constitutes a lack of disclosure giving rise to additional civil liability and possibly criminal exposure.

Further, because Shariah is understood as divine and the Shariah authorities are considered the trustees of its authority, integrity and interpretation, the application of Shariah’s well-established and ancient doctrines to the quite modern practice of SCF necessarily lacks transparency.

Shariah is, by its own terms, a divinely ordained law which can never be subordinated to a secular political, legal or regulatory system. As a result, Shariah is simply not a positive law or normative system that is articulated and enforced within a political structure of codified laws, procedures, courts and binding legal opinions. In the absence of such mechanisms and the precedence and effective enforcement mechanisms they provide, there will, by definition, be a lack of transparency in Shariah-governed transactions.

SCF represents nonetheless an attempt by the participants (financiers, businessmen, facilitators, and Shariah authorities) to apply divine law to a modern secular political, legal and financial system. Should a secular court or legislature attempt—in an effort to establish transparency –to codify Shariah’s precepts as they apply to SCF (setting aside the constitutional issues this would raise in the United States), it would fail its fundamental purpose: Shariah simply cannot be rendered subservient to secular law.

In stark contrast, domestic finance and commerce in the United States, and indeed international financial transactions more generally, are based upon Western legal financial structures which provide transparency. It is transparency that 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 previously been used successfully after being stress-tested and enforced in many forums under various circumstances, 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.

The problem the SCF industry currently faces is that none of this analysis has been conducted, and if it has, the results of this analysis have been buried in the Shariah black box without any of the disclosures required by U.S. law. What follows is a survey of those laws and the implications for U.S. financial institutions engaged in SCF.

Common Law Tort Action for Deceit or Fraud

The common law of most states incorporates the tort action of deceit, commonly referred to as fraud, to allow private rights of action for misrepresentation.

The essential elements of a common law fraud action are:

  1. a false representation of
  2. a material fact which
  3. the defendant knew to be false with the intent
  4. to induce the plaintiff to rely upon it and
  5. the plaintiff in fact justifiably relied upon the representation, thereby
  6. suffering damages as a result.

Most states have relaxed many of the provisions governing common law fraud. For example, certain relationships under the common law (such as a fiduciary) might also give rise to a claim for constructive fraud which allows recovery for an omission of material fact. In other words, not providing material facts about Shariah and Shariah advisors could be such an omission, and the basis for a claim filed under the common law of the plaintiff’s state.

How to Apply Federal and State Securities Laws to SCF

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. Civil and criminal liability under the federal securities statutes for failure to disclose, what is broadly referred to as securities fraud, 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”).

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 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.” The SEC—through its rule-making authority and its regulatory responsibilities—dictates the specific kinds of minimal (and in some cases maximal) disclosure required by the specific provisions.

The main weapons against securities fraud are the civil and criminal remedies. Thus, the SEC, in addition to administrative sanctions, has access to the civil courts to seek injunctive relief, disgorgement and even civil fines, in addition to other equity-like relief. In addition, the Department of Justice (“DOJ”), 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.

Finally, private plaintiffs have expressed and implied rights of action under several provisions. The most used and abused of all such provisions is Rule 10b-5 promulgated under the 1934 Act which provides for civil litigation and criminal prosecutions. When the class-action club is added to the civil claims brought under Rule 10b-5—although curbed significantly by recent legislation—the weapons available to prosecute claims for misstatements and omissions of material fact in SEC filings and elsewhere in the public domain are considerable.

The private sector may also play a role in investigating the risks of SCF, in educating the public and in taking initiatives under existing regulations to enforce the law through civil litigations and to employ provisions such as Rule 10b-5 to hold SCF financial institutions accountable for knowingly or recklessly withholding the whole material truth about Shariah.

State securities laws, usually referred to as blue sky laws, are similar to the securities disclosure laws and securities fraud liability in federal securities laws. However, as a result of Congress’ efforts to curb private securities fraud litigation and recent Supreme Court rulings, the more sweeping state securities laws will take on ever greater importance in the securities plaintiff’s arsenal of litigation weapons.

Shariah, Law and ‘Financial Jihad’: How Should America Respond? Rep. Chicago: The McCormick Foundation, 2008. pp. 53-54.

How might Shariah Advisory Boards violate U.S. Anti-Trust and Collusion laws?

Another area of civil liability exposure arises under antitrust law, imposed by the need for Shariah authority boards. At present, approximately sixty Shariah scholars monopolize the positions available on the Shariah advisory boards of major SCF institutions worldwide.

There has been a concerted effort among these Shariah authorities to impose universal standards to prevent materially divergent opinions. This effort has been spearheaded by the Accounting and Auditing Organization for Islamic Financial Institutions (“AAOIFI”) and the Islamic Financial Services Board (“IFSB”). The former seeks to establish accounting standards for the various SCF transactional structures. The latter is striving to set the standards by which Shariah authorities self-regulate and interact with the financial institutions which employ them. According to the IFSB, the AAOIFI and the independent writings of many of the Shariah authorities, there are designs to establish industry-wide minimal credentials a newcomer would be required to obtain to enter this lucrative consulting business. The initial antitrust issue raised by such efforts is the problem of “group boycotts” or, alternatively, the implication of “self-regulation” for a small, discreet and insular group of authorities who have almost total market share deciding how one gains entry into the market.

Applying their standard “rule of reason,” courts will look to the motivations and anti-competitive effects of such “industry standards.” This is especially problematic in SCF because, should a non-recognized Shariah authority attempt to market his services to the financial institutions seeking Shariah guidance, a ruling by the existing Shariah authorities that the newcomer has not satisfied their credentialing requirements would, as a practical matter, render the market closed to that newcomer.

The “closed-shop” quality of SCF will exacerbate this syndrome. Financial institutions that market SCF products to the Shariah-adherent consumer are extraordinarily sensitive to the problem that public disputes among the Shariah authorities over what is permitted or prohibited could devastate the demand for SCF products generally. At the very least, they could certainly render suspect any given SCF product.

The problem of “self-regulation” would become an issue for the financial institutions themselves if they play some material part in this effort to control entry into the market by newcomers, whether via de jure or de facto collusion with the dominant group. Another problem, however, which would certainly implicate liability for the financial institutions directly, is what has been described as “rules collusion.”

In the latter case, the effort by the financial institutions and their agents— the Shariah advisors—to agree upon what transaction structures and investments should be considered “Shariah-compliant” will most assuredly work to limit the development of new competitive products by the market players. The effect will be further to shape and minimize competition among cartel members in order to increase the profits of the parties to the agreement. SCF presents substantial antitrust liability exposure.

Shariah, Law and ‘Financial Jihad’: How Should America Respond? Rep. Chicago: The McCormick Foundation, 2008. pp. 50-51.

How Might Shariah Finance Engage in Material Support of Terror and Reverse Money Laundering?

SCF follows the Shariah obligation to tithe (known as zakat) and also requires the “purification” of profits earned in violation of Shariah. There are a number of questions that lawyers, investors, policymakers and the general public need to ask of Shariah-compliant funds and regulators:

  • Who decides what happens to the zakat funds?
  • Which charities are selected, and by what criteria?
  • What tracking mechanisms are in place to trace these funds?
  • If regulators usually do not know which charities are being funded, and no tracking mechanism is in place, is this due to ignorance of the potential for funding terrorism, or willful blindness?
  • Who is liable if Shariah-compliant funds are indeed funding terrorism and training for jihadists: the funds themselves? The regulators? The investors? The shariah advisors?

Given the historical connection between some of the largest and best known Muslim charities and the funding of terrorist groups, these questions take on added focus in the context of material support of terrorism. As the foregoing analysis makes clear, there is, in fact, a close nexus between Shariah and global terrorism. At the very least, efforts by corporate legal counsel to dismiss these concerns will invariably run up against the wall of common understanding linking the two. In fact, this common understanding has already begun to articulate itself in the debate over materiality in the context of what is a material or relevant disclosure with respect to shareholder proxy statements demanding disclosures of what has come to be termed “global severity risks.”

U.S. companies can no longer consider their associations with countries or entities tainted by terror a private, non-material or irrelevant matter. While the courts have not yet entered the fray, the executive and legislative branches have laid down some important markers. The closer a company gets to any association with terror, the more it has to disclose.

Shariah, Law and ‘Financial Jihad’: How Should America Respond? Rep. Chicago: The McCormick Foundation, 2008. pp. 51-53.

Reverse Money-laundering

Shariah-compliant finance appears to constitute a form of what has been called “reverse money-laundering.” After all, it stands the classic money-laundering model on its head—moving perfectly legitimate funds into U.S. domestic businesses via SCF, then diverting those funds to domestic or overseas charities and organizations, at least some of which have ties to terrorism. Such transactions are very difficult to spot unless government regulators already have the specific recipient charities and organizations in question under surveillance.

As discussed above, this danger arises from two practices associated with Shariah-compliant finance. The first is through a charitable contribution made on behalf of individual investors by an SCF financial institution or business. This practice is rooted in the obligation of faithful Muslims to gift a certain percentage of their income to charity.

In the Middle East and Malaysia, SCF companies, banks, and investment funds seem to calculate the amount the individual Muslim investors owe from profits and to distribute those funds automatically to Shariah-approved charities. Only then would the net, after-Shariah-charitable-tax profits be distributed to the individual investor.

In the United States, although many of the reporting companies and mutual funds involved in SCF are unclear as to whether this service is offered, most appear to allow the individual investor to calculate and make his or her own charitable contribution.

Several questions arise for those SCF businesses and investments which net the returns to the investor after this charitable payment:

  • Which charities are Shariah-compliant?
  • Who makes this determination?
  • Do the businesses or financial institutions direct these contributions or are these decisions made by the Shariah authorities?
  • Is there any vetting of the recipients of these charities to determine what they do with these funds?
  • Why is this process not transparent?

A second troubling SCF practice contributing to reverse money-laundering arises when some of the gross income of a business deemed Shariah-compliant is generated by Shariah-prohibited sources. This can occur in several ways, but two are most common:

The first is via what one might term the exceptional event when the Shariah “filter” misses some tainted source of income altogether. This might happen, for example, when a Shariah-compliant company in a Shariah-compliant mutual fund acquires a forbidden company, the main business of which is in a forbidden industry (such as interest-based finance or hog farming). The equity position in that Shariah-prohibited company must be sold. The proceeds of that sale will include a certain amount of profits attributed to the forbidden assets. That amount must be calculated and “purified” by being donated to an approved “charity.”

The second occasion for purification is more typical. For instance, a mutual fund is permitted to invest in companies which routinely earn up to a fixed percentage of their income from interest (e.g., via overnight “float” operations). Notwithstanding this leniency, any profits thus accruing to the mutual fund from this forbidden income must be “purified.”

Not surprisingly, Shariah advisors typically insist that such purification be performed by the SCF institution so they will have the opportunity properly to assess the amount needed to be purified and, presumably, to determine to which charities the purified funds flow. As with the zakat charitable contributions, the purification of funds is, as a general rule, not fully disclosed in public filings of U.S. SCF financial institutions.

The three largest Muslim charities in the United States have all been implicated in financing terror, had their assets frozen, and they were effectively shut down. The criminal exposure arising from the “purification” process leads one to ask the following questions about any list of potential charities: Are these non-Muslim charities? If they are Muslim charities, have they been vetted and by whom?

In fact, the practice of Muslim charities funneling money to terrorists is so widespread and the problem so insidious that the U.S. government keeps a list of dozens of such organizations worldwide. It will not suffice, however, to simply determine that the charities are “well-known” Muslim charities and not currently listed as designated supporters of terrorism. At a minimum, the following questions would need to be answered:

  • Who are the ultimate beneficiaries of the contributions?
  • Who or what is the ultimate purpose served by the charities’ “good deeds”?
  • Do these charities have overseas branches?
  • Is the financial institution wiring the funds domestically or internationally?
  • Who or what organization founded the charities and who controls them today?

Shariah, Law and ‘Financial Jihad’: How Should America Respond? Rep. Chicago: The McCormick Foundation, 2008. pp. 45-46.

How Might Shariah Finance Engage in Racketeering?

The Racketeer Influenced and Corrupt Organizations Act (commonly referred to as RICO) is a United States federal law that provides for extended penalties for specific criminal acts carried out as a “pattern” and performed as part of an ongoing criminal enterprise. The predicate offenses which can qualify as part of the “pattern of racketeering activity” include bank fraud and money laundering. Since the passage of the Patriot Act, money laundering offenses include “material support of terrorism”.

Section 2339(A) of Title 18 of the U.S. Code, states: “Whoever, within the United States or subject to the jurisdiction of the United States, knowingly provides material support or resources to a foreign terrorist organization, or attempts or conspires to do so, shall be [guilty of a crime].”

“Material support” is defined in the U.S. Code as:

  1. the term “material support or resources” means any property, tangible or intangible, or service, including currency or monetary instruments or financial securities, financial services, lodging, training, expert advice or assistance, safe-houses, false documentation or identification, communications equipment, facilities, weapons, lethal substances, explosives, personnel (one or more individuals who may be or include oneself), and transportation, except medicine or religious materials;
  2. the term “training” means instruction or teaching designed to impart a specific skill, as opposed to general knowledge; and
  3. the term “expert advice or assistance” means advice or assistance derived from scientific, technical or other specialized knowledge.

The thrust of the RICO case that applies to Shariah-compliant financial transactions rests in part on the fact that, as has been noted above, such prominent Shariah advisors as Sheikhs Qaradawi and Usmani have both issued fatwas that provide material support to Jihadists the world over. These advisors intend for Shariah-adherent jihadists to use their fatwas as legal authority to engage in murder and terrorism. In other words, they know or have reason to believe that their fatwas constitute such support.

Moreover, all of the Shariah authorities who confer with Usmani and Qaradawi—even ones who do not personally issue such violence-inspiring fatwas—are guilty of aiding and abetting the material support of terrorism because they are knowingly participating by providing greater authority to such rulings even as they themselves avoid personally issuing rulings on Jihad.

RICO is violated when a defendant—or, in this case, a cadre of defendants acting as Shariah authorities—engage in a “pattern of racketeering activity” and have:

  1. Invested income from a pattern of racketeering activity in an “enterprise”;
  2. Acquired or maintained an interest in an “enterprise” through a pattern of racketeering activity;
  3. Conducted or participated in the affairs of an “enterprise” through a pattern of racketeering activity; or
  4. Conspired to do any of the above.

Shariah, Law and ‘Financial Jihad’: How Should America Respond? Rep. Chicago: The McCormick Foundation, 2008. pp. 12-13.

How Might Shariah Finance Constitute Sedition or Conspiracy to Overthrow the U.S. Government?

Insofar as authoritative Shariah clearly entails the realization of a transnational Islamic theocratic state, its adherents are committed to, among other things, the overthrow of the U.S. government, through violent means if necessary. Federal statutes define such activity as sedition and prohibit it. Specifically, a statute known as the Smith Act (18 U.S. Code § 2385), states:

Advocating overthrow of Government

Whoever knowingly or willfully advocates, abets, advises, or teaches the duty, necessity, desirability, or propriety of overthrowing or destroying the government of the United States or the government of any State, Territory, District or Possession thereof, or the government of any political subdivision therein, by force or violence, or by the assassination of any officer of any such government; or

Whoever, with intent to cause the overthrow or destruction of any such government, prints, publishes, edits, issues, circulates, sells, distributes, or publicly displays any written or printed matter advocating, advising, or teaching the duty, necessity, desirability, or propriety of overthrowing or destroying any government in the United States by force or violence, or attempts to do so; or

Whoever organizes or helps or attempts to organize any society, group, or assembly of persons who teach, advocate, or encourage the overthrow or destruction of any such government by force or violence; or becomes or is a member of, or affiliates with, any such society, group, or assembly of persons, knowing the purposes thereof— Shall be fined under this title or imprisoned not more than twenty years, or both, and shall be ineligible for employment by the United States or any department or agency thereof, for the five years next following his conviction.

If two or more persons conspire to commit any offense named in this section, each shall be fined under this title or imprisoned not more than twenty years, or both, and shall be ineligible for employment by the United States or any department or agency thereof, for the five years next following his conviction.

As used in this section, the terms “organizes” and “organize,” with respect to any society, group, or assembly of persons, include the recruiting of new members, the forming of new units, and the regrouping or expansion of existing clubs, classes, and other units of such society, group, or assembly of persons.

The U.S. Supreme Court has, on four separate occasions, upheld the Smith Act against a variety of constitutional challenges. In the context of these decisions, the Court has made it clear that a conviction for advocating the violent overthrow of the U.S. Government will stand when the prosecution can establish:

  1. the call for violence is not merely theoretical;
  2. that there is a real nexus between the call for violence and actual behavior; and
  3. the violent acts are likely to occur immediately or in the future.

While some courts and commentators have understood the Court’s rulings on “incitement” to require “imminent lawless acts” [citing to Brandenburg v. Ohio, 395 U.S. 444, 447 (1969) (per curiam)], the Smith Act criminalizes seditious behavior that is more akin to criminal solicitation and conspiracy than incitement.

The call for violence and violent jihad by Shariah authorities is a paradigmatic violation of the Smith Act. The Mohammed cartoons are a historical example of how the fatwas from leading Ulema (Shariah authorities) lead inexorably to violence. Shariah-based fatwas are not theoretical or theological: they are mandates for behavior to the Shariah faithful. The cartoons had been in the public domain for months without incident until the Ulema called for a Day of Rage and invariably and inevitably violence and murder throughout Europe, the Middle East and Southern Asia. The lesson learned from the cartoon-related violence was not its immediacy but its inevitability, once the fatwas had been issued.

Authoritative Shariah scholars must, in accordance with their traditions and practice of Islam, advocate the Law of Jihad against the United States. This advocacy falls well within the requisites of the Smith Act as refined by the Supreme Court. Shariah, as in the fatwas that result in violence, functions as a set of legal and normative instructions for jihad to the Shariah faithful. As will be discussed below, U.S. corporations that employ such scholars as advisors in connection with the firms’ Shariah-compliant finance related activities have increased civil and criminal exposure not otherwise associated with financial transactions.


 

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