Shariah’s Black Box

Another exogenous factor has been addressed by the academic and professional SCF literature. A significant focus of SCF publications describes the dearth of competent Shariah authorities worldwide. This is due to the fact that while Shariah authorities are apparently available in sufficient numbers to answer the needs of the Shariah-adherent communities worldwide[253], there is a major shortage of these authorities who are sufficiently versed in modern finance and commerce and with a working knowledge of English to handle the international documentation which invariably are drafted with an eye towards institutions working out of London or New York. Insofar as there are only approximately 20-25 sufficiently trained Shariah authorities, each of these exclusive club members sits on dozens of the Shariah supervisory boards around the world. The result is a small clique which advises the lion’s share of competing financial institutions on how to develop new SCF products and transaction structures.[254]

The legal advisor must evaluate the disclosure issues given the fact that a Shariah authority’s rulings and artful craftsmanship in finding new transactional structures to avoid Shariah prohibitions might very well differ from one institutional client to another given the relative financial remuneration. Furthermore, are there issues that ought to be disclosed to a reasonable investor relating to confidentiality and the systems put in place to protect confidentiality? What duty of care do the Shariah authorities owe the financial institutions? Are they considered experts for purposes of the 1933 Act? Do they participate in writing the portions of the registration statement or prospectus that deals with Shariah?

In all of these areas, and more, the materiality and scienter issues discussed above will play into the calculus for the legal advisor as the examination of these and other exogenous elements unfold. An additional facet of the disclosure complex, especially as it relates to the scienter standard of recklessness, is the implication for the financial institutions and their professional advisors of a duty to conduct a reasonable due diligence to make certain that what they have said about SCF is the whole of the material truth.

2.       Due diligence

The articulation of a breach of duty to disclose is closely related to the duty to exercise reasonable due diligence as either an element of scienter or a defense where scienter is not at issue. For example, under the 1933 Act, Sections 11 and 12(a)(2) provide for a due diligence defense for certain defendants who have failed to disclose all relevant material facts.[255] The case law and literature on these defenses is extensive and legal counsel for any financial institution will have to consider long and hard the implications of ignoring the exogenous structures set up for a Shariah-compliant investment or business. At the very least, each of the exogenous disclosure issues should be the subject of a carefully prepared legal opinion. Failure to rely on expert legal opinion will likely expose the financial institution and its management to far greater liability insofar as failure to do so might rise to the level of a reckless breach of the duty of care expected in the industry. The duty to rely on a formal legal opinion intimates the lawyer’s exposure to liability for failure to conduct a reasonably competent investigation. In the case studies presented in Section III below, this memorandum begins to pry open these issues for further discussion among legal scholars and professionals.