Shariah’s Black Box

(i)    The Supreme Court’s standards

Materiality is a fundamental element for an action alleging a failure to disclose under the securities laws and this is certainly the case for a plaintiff alleging that a defendant violated such duty by not properly disclosing the real nature, purpose, and scope of Shariah. The essential elements of such a claim might be, in addition to those set forth above in the hypothetical factual predicate for this discussion, as follows:

(1)    Plaintiff bought shares in a closed-end mutual fund which represented itself to be Shariah-compliant.

(2)    An important part of these representations was the high-repute of the Shariah advisory board members who were to watch over the fund’s Shariah compliance.

(3)    Various representations by the defendant financial institution and its agents and representatives spoke of the ethical and socially responsible nature of Shariah.

(4)    It was subsequently discovered and made public that the Shariah advisory board members all treated the rulings and pronouncements of Ibn Taymiyyah, a fourteenth-century Hanbali Shariah authority and scholar “with strikingly modern-sounding views” on commerce and finance[177], as authoritative. It was also discovered and made public that Ibn Taymiyyah was a key Shariah authority for most of the terrorists associated with al Qaeda. Ibn Taymiyyah, it turns out, was a leading advocate of a Shariah centered political organization for Muslims which would declare holy war against infidels and Muslims who rejected Shariah. In fact, all sorts of “Islamists” who have declared war on the U.S. and seek the establishment of a worldwide Caliphate are students and followers of the Shariah “rules and principles” espoused by Ibn Taymiyyah insofar as he advocates Muslims to war against infidels.[178]

(5)    There is a consensus among Shariah authorities from all schools of Shariah jurisprudence that forced subjugation or Jihad against non-Muslims is obligatory when efforts to peacefully convert the non-Muslims fail and war is a viable option.

In addition to these allegations which would support an SEC enforcement action or a private right of action for rescission, a plaintiff might opt to pursue damages. In such a case, one might anticipate the following: When the information alleged above became public knowledge, the fund suffered irreparable reputational damage and many of the U.S.investors sold their shares in the mutual fund causing the value of the traded shares to plummet. The complaint would also allege that the plaintiff purchased shares in the mutual fund without knowing anything about Shariah other than what the defendants represented to the public. Since the defendants promoted their Shariah authority board members as highly respected scholars and authorities in their field and since these authorities ruled that Shariah forbade interest and excessive speculation in investments, and also prohibited investing in various “vice” industries, the plaintiff reasonably relied on these representations in the belief that Shariah was a “socially responsible” business practice and worth utilizing as an investment “screen”. Had the plaintiff known the facts about Shariah as they have now come to light, plaintiff would never have invested in a Shariah-compliant mutual fund. In addition to damages, the plaintiff would likely apply to certify the class of similarly situated investors.

The first issue confronting the plaintiffs under Rule 10b-5, the broadest of the federal securities anti-fraud statutes, will be whether the omissions of fact relating to Shariah doctrine relative to the treatment of apostates (both non-Muslims and Muslims) were material. Insofar as this question of materiality as phrased would be one of first impression for an appellate court, legal counsel advising a U.S. financial institution on the liability exposure for SCF would turn to the courts’ general pronouncements for guidance. The leading decision in this area is TSC Industries, Inc. v. Northway, Inc.,[179] where the Supreme Court was asked to wade into the question of whether a failure to disclose in the context of a proxy solicitation was material. The case involved the acquisition of the target company TSC Industries by National Industries through the purchase of a controlling interest. After the acquisition, National Industries sought to acquire all of the assets of TSC Industries and to liquidate the corporate shell. To accomplish this, TSC Industries issued a proxy statement to its shareholders soliciting their approval. The vote passed. A shareholder of TSC Industries, Northway, Inc., sued under section 14(a) of the 1934 Act (“Section 14(a)”) and the SEC rules promulgated thereunder, Rules 14a-3 and 14a-9. [180] The essential material fact at issue was who was really in control. While the Court ultimately concluded that there were sufficient disclosures to inform a reasonable investor, the analysis the Court used to get to that conclusion provides the basis today for the materiality analysis.