Ethics: Inherent In Islamic Finance Through Shari'a law; Resisted In American Business Despite Sarbanes-Oxley
Fordham Journal of Corporate & Financial Law
Copyright c 2007 by the authors. Fordham Journal of Corporate & Financial Law is produced
by The Berkeley Electronic Press (bepress). http://ir.lawnet.fordham.edu/jcfl
Ethics are inherent in Islamic finance and are accepted by those
wishing to enter the marketplace of Islamic finance; however, in
America where ethics have only recently been integrated through
Sarbanes-Oxley into our existing system of business, ethical compliance
is met with resistance. Islamic financing is based on a system of ethics
derived from the principles of the Quran.1 These ethical principles are
applied to the financial industry through Shari’a law.2 Shari’a law
governs all business transactions of devout Muslims who must be in
compliance with Shari’a law in order to observe the principles of Islam
articulated in the Quran.3 As wealth has increased in the hands of
∗ J.D. candidate, Fordham University School of Law, 2008; B.A., Manhattanville
College, 2005. I would like to thank Professor Jill Fisch, T.J. Maloney Chair in
Business Law, Fordham University School of Law, for her guidance; and Mary Cheasty
Kornman, Associate Dean & Director, Career Services, Manhattanville College, for her
advice and ideas. Also, I would like to thank the members of the Fordham Journal of
Corporate & Financial Law for their diligent editorial assistance.
1. HSBC Amanah, The Concept, available at http://www.hsbcamanah.com/hsbc
/amanah_banking/the-concept (last visited Feb. 1, 2007) [hereinafter HSBC Amanah,
The Concept]. Quran is also seen spelled “Koran” or “Qur’an.”
2. Id. Shari’a is spelled in a variety of ways. I have chosen to use this spelling
since it is the spelling used in the text of the Accounting and Auditing Organization for
Islamic Financial Institutions (“AAOIFI”) standards. Other spellings include Shariah,
Shari’ah, and Sharia.
3. Jerry Useem, Banking on Allah, devout Muslims don’t pay or receive interest.
So how can their financial system work?, available at http://money.cnn.com
/magazines/fortune/fortune_archive/2002/06/10/324525/index.htm; see also, HSBC
Amanah, The Concept, supra note 1.
Shari’a compliant Muslims, so has the opportunity and demand to create
Shari’a compliant investments.4 Regulatory standards have been created
by the Accounting and Auditing Organization for Islamic Financial
Institutions (“AAOIFI”) to standardize the governance of every Islamic
business product and service.5 Any institution offering a Shari’a
investment product must conform to the ethical principles of Shari’a law
set forth in the Accounting, Auditing, and Governance Standards for
Islamic Financial Institutions created by the AAOIFI.6 The principles of
Shari’a are enforced and monitored by Shari’a scholars through the
issuance of a “fatwa,” a religious blessing, certifying Shari’a
compliance, at which point the investment product is deemed a Shari’a
In response to corporate governance failures such as Enron, the
United States took the first stride towards adopting a similar, ethical
business model.8 The Sarbanes-Oxley Act of 2002 heightened
disclosure requirements and raised the level of accountability.9
Sarbanes-Oxley introduces ethical principles to the United States
corporate environment through the application of many rules.10
Currently, however, there is a backlash against Sarbanes-Oxley as it is
perceived as being too costly,11 demonstrating the continued chasm
between ethics and corporate law in America.
II. ETHICS IN ISLAMIC FINANCE
Islamic finance flows from the principle that religion cannot be
divorced from any aspect of life, including business.12 Shari’a law
governing Islamic finance is derived from the guidance from God found
in the Quran and the Sunnah (teachings) of the Prophet Muhammad.13
This necessitates tailoring conventional financial practices to fit within
religious rules stemming from as far back as the time of Muhammad in
632 AD.14 Therefore, the industry of Islamic banking is quite distinct
from the modern and secular investing practices of the West. This
distinction creates an opportunity for Western financial institutions to
create Shari’a compliant products and expand into this burgeoning
A. Growing Demand
There is an increasing population of people looking for financial
products consistent with their religious beliefs.16 The increase of money
in the Middle East reflecting the growth of the oil industry has had a
positive impact on the Islamic banking industry.17 The wealth in the
Middle East has created a demand on the Islamic banking industry and
an incentive for American companies to provide different investment
options to meet this demand.18 In order to capitalize on this demand and
serve the market, American investment firms must create AAOIFI
Recently, the Middle East, itself, has served the Islamic market by
offering many new investment products.19 The Islamic financial
movement began in 1973 with the creation of the Islamic Development
Bank.20 The 1970’s oil boom put money in the hands of many Muslim
nations that wanted to adhere to their Islamic values.21 Since then, the
Islamic banking industry has grown about 10% to 15% per year.22 In
the past year or two, the high price of oil has shifted an enormous
amount of wealth to the Middle East.23 Current estimates show that the
oil exporters’ current-account surplus could reach $400 billion.24 In
addition to this current amount of wealth, it is predicted that the demand
for oil and gas will increase by 50% in the next thirty years and that the
Middle East is going to meet this demand.25 Further, there are also over
1.5 billion Muslims in the world today,26 making up 20% of the world’s
population.27 The United States alone is home to seven million
MuslimAmericans.28 Currently, the worldwide Islamic banking industry
consists of over 300 institutions holding several billion dollars.29 This
represents a huge potential market in which financial institutions in the
United States can offer diversified-alternative-Islamic-compliant
financial instruments. American banks are just beginning to enter this
market and offer Shari’a compliant investment opportunities.30 The
development of viable Shari’a alternatives to conventional Western
investments will allow for Muslim participation in the worldwide
B. Distinct From Conventional Financial Structures
Islamic financial models are unique in that ethics are intertwined
with their operations.32 Islamic governance takes into account the social
implications of a business transaction and thereby serves the greater
community interests.33 One of the main tenets upon which Islamic
banking law rests is the prohibition on interest or “riba”.34 The concept
is meant to outlaw all forms of wrongdoing and give the financier an
interest in the venture.35 Not only does the doctrine of “riba” prevent
the exploitation of someone in a weak bargaining position, but it also
forbids “all forms of gain or profit which were unearned in the sense that
they resulted from speculative or risky transactions and could not be
precisely calculated in advance by the contracting parties.”36 The
prohibition of interest is meant to design an economy and society based
on risk-sharing, fair dealing, and equity.37 In Islamic law, the
justification that interest is the cost of using money or that a loan is an
investment is rejected in favor of ethics.38
Islamic economic theory criticizes the conventional financial
industry for speculation, consumerism, volatility, “unnecessary
products,” large corporations, and usury.39 These traditional capitalistic
means of profit-making are not compatible with Islamic values.40
Islamic law therefore creates a culture where people only spend what
they have, a theory in direct opposition to consumer driven models.41
Investment regulations are implemented to avoid “sinful” activity.
Currency hedging, futures contracts, day trading, and credit cards are all
prohibited under Islamic law.42 In addition, companies with excessive
debt, interest-bearing securities and accounts-receivables in their assets
are screened out.43 Islamic law further prohibits support of industries
such as alcohol, gambling, pork-related products, tobacco, weapons,
conventional financial services and other “immoral” activities.44 In
response to this investment criterion, a Dow Jones Islamic Index was
created in 1999 to screen out stocks that did not comply with these
beliefs.45 The index tracks securities that are approved by the Shari’a
Supervisory Board of the Dow Jones.46 The screen eliminates
businesses that make 5% or more of their revenue from activities
deemed “sinful” and prohibited under Shari’a.47 When a company
makes less than the 5% level of revenue from a sinful activity, a
compliant investor can invest in the company, but must donate to charity
the same proportion of his dividends as the company’s revenue from a
“sinful” activity.48 Risk mitigation is essential to producing structures
that comply with Islamic finance.49 Therefore, since the stock market is
inherently risky, stock market transactions are only permitted when the
ethical elements of Islamic law are adhered to.50 Although based on
Islamic principles, such a screening process, which excludes firms that
are particularly risky, may be attractive to any conservative investor, not
only to Muslims who are interested in accountability and the social
responsibility of the company.51 The Dow Jones Islamic Fund
integrates the ethical principles of Shari’a law into modern equity
C. Sharing the Profits and Losses
The theoretical model of Islamic banking is based on the sharing of
both profit and loss.53 The assumption being that direct investment into
ventures leads to more prudent lending.54 Investors are more interested
in the outcome when the success or failure of the venture determines the
amount of profit or loss.55 The concept is that a financier of a venture
should not be guaranteed a profit without sharing in the risk.56 If the
entrepreneur, who puts in the hard work is not guaranteed a positive
return, why should someone profit who is not putting any work in at
all?57 In practice, this means that an Islamic bank provides the capital to
a firm, and then shares with its clients the profits and losses of the return
on this investment.58 Although this is the theoretical model of Islamic
banking, profit-loss sharing models of financing actually constitutes
only about 20% of Islamic compliant investments.59
The reason for the minimal use of the profit and loss sharing model
is because entrepreneurs are not likely to share their profits when
optimistic, and capitalists are of course hesitant to bear risk knowing that
the opportunity signals the improbability of its success.60 Those
entrepreneurs, who are confident in their venture’s success, are more
likely to secure financing that is fixed-interest in order to maximize their
own returns.61 Whereas those entrepreneurs who anticipate their venture
will fail may welcome the idea of sharing the loss.62 Profit and loss
sharing is a risky investing vehicle because banks lack the right to
monitor the operations of the firms in which they are invested.63 The
concept of control-rights is at the heart of who should be earning a profit
or incurring risk or loss.64 Without the conventional guarantee of return,
profit and loss sharing represents a risk; however, the theory of fairness
makes profit and loss sharing the ideal concept of investment in Islamic
Profit and loss sharing, although present in the United States
through venture capitalism, is not a conventional means of banking or
deposit. Western banking is based on the premise of depositing the
principle without risk, as opposed to profit and loss sharing where the
initial deposit is gambled.66 With profit and loss sharing, the return on
the investment is based on the profits earned from the investment, rather
than a set rate.67 Therefore, where profit loss sharing is substituted for
conventional savings account, then the guarantee of fixed-interest
income is eliminated, and the principle investment is jeopardized.68
This theoretical model also differs from conventional venture capitalism
in that the customer does not have any input into the decisions on what
the principle is invested in.69 In the venture capitalist framework in
America, management and control of the venture are essential.70
Muslims are not likely to use profit and loss sharing as a means of
banking as Americans do in conventional banks, where there is a fixed
return on the principal.71 Since this model has yet to be realized, a
significant opportunity exists for those willing to offer Shari’a compliant
D. AAOIFI Standards
Financial institutions that are interested in the opportunity to serve
the Islamic market must comply with AAOIFI standards.73 In 1991, the
Islamic banking industry decided that the existing standards did not
provide sufficient guidance.74 The AAOIFI took on the tasks of setting
and enforcing the industry standards.75 The AAOIFI was instituted in
order for scholars on Shari’a law to create standards of financing that
complied with the religious laws.76 At the heart of the AAOIFI
standards is the key concept in Islamic jurisprudence of “collective
personal reasoning,” referred to as “ijtihad,” as opposed to “individual
personal reasoning.”77 AAOIFI standards are meant to help companies
understand and supervise Islamic finance and fit it within their own
regulatory scheme.78 In addition, since compliance with Shari’a law is
required of all Muslims in their banking transactions, it is believed that
accepted financial standards that create disclosure and access to
information will increase user confidence and therefore increase
investment.79 The AAOIFI set forth the objectives of financial
accounting in order to create the disclosure requirements.80 Some of the
AAOIFI mandates include:
(1) Develop the accounting, auditing and banking
practices thought relating to the activities of Islamic
(2) Disseminate the accounting and auditing thought
relating to the activities of Islamic financial
institutions and its application through training,
seminars, publication of periodical newsletters,
preparation of research and other means;
(3) Prepare, promulgate and interpret accounting and
auditing standards for Islamic financial institutions in
order to harmonize the accounting practices adopted
by these institutions in the preparation of their
financial statements, as well as to harmonize the
auditing procedures adopted in auditing the financial
statements prepared by Islamic financial institutions;
) Review and amend the accounting and auditing
standards for Islamic financial institutions to cope
with developments in the accounting and auditing
thought and practices; and
) Approach the concerned regulatory bodies, Islamic
financial institutions, other financial institutions that
offer Islamic financial services, and accounting and
auditing firms in order to implement the accounting
and auditing standards, as well as the statements and
guidelines on the banking, investment and insurance
practices of Islamic financial institutions that are
published by AAOIFI.81
The main standard developed through the AAOIFI is the
communication and disclosure of relevant financial information to the
public.82 The regulatory framework seeks to increase the number of
products available to Muslims and investments made by Muslims by
outlining the standards, and deeming that, when they are met,
compliance is assured.83
Each conventional institution that offers Islamic financial services
is required to “appoint a Shari’a supervisory board, which shall present a
Id. at Introduction p. x.
Id. at Accounting p. 7.
Shari’a report, and to implement the Governance standards issued by
AAOIFI that relate to the Shari’a supervisory board.”84 This board is
focused on insuring that all transactions comply with Shari’a law.85 The
board is required to disclose any financial transactions that are not
compliant with Shari’a law and to make all disclosures relevant to assist
an investor in evaluating risks inherent in the assets and the liquidity of
the investment.86 This requires directing and reviewing the activities of
the Islamic products.87 The supervisory board’s decisions are binding
on the institution.88
Another major role that Shari’a scholars play is the issuance of
Fatwas, a religious blessing that certifies compliance with Shari’a law.89
Without this blessing, compliance is not deemed to be met.90 The
issuance of a Fatwa signifies that the transaction is “halal,” meaning that
it comports with Shari’a law.91 Building a relationship between Shari’a
scholars and the company is a crucial component of compliance to
ensure continual oversight.92 Trust and teamwork between the Shari’a
board and the company is fundamental to the development of an
As a part of the corporate governance regulations, the AAOIFI
issues standards for auditing practices.94 It states:
The objective of an audit of financial statements is to enable the
auditor to express an opinion as to whether the financial statements
are prepared, in all material respects, in accordance with the Shari’a
Rules and Principles, the accounting standards of the Accounting and
Auditing Organization for Islamic Financial Institutions (AAOIFI),
and relevant national accounting standards and practices in the court
in which the financial institution operates.95
Auditors’ reports are expected to “give a true and fair view.”96
These governance standards are based on principles of professional
conduct.97 The general principles of an audit are (1) righteousness, (2)
integrity, (3) trustworthiness, (
) fairness, (
) honesty, (
) objectivity, (
) professional competence, (
) due care, (
) professional behavior, and (
standards.98 In addition, an internal review is to be conducted to
determine compliance with Shari’a rules.99
E. Islamic Compliance
Compliance with these auditing and accounting standards is very
costly because of the extent of monitoring and disclosure.100 In addition,
developing investment strategies that comply with Islamic banking
principles is distinct from the strategies used for conventional
investments.101 Western banks generally invest in fixed income,
interest-bearing securities.102 Such investments are prohibited by
Shari’a law.103 Unlike the fundamental principle in conventional
banking for “project finance” which prefers the use of debt in order to
leverage the project,104 Islamic financing prefers equity over debt.105
Under Islamic financing, conventional debt has been replaced with
asset-backed debt financing.106 For instance, a savings account that is
compliant with Shari’a law invests money directly into ventures instead
of merely earning fixed interest.107 Profits can be made, but they cannot
be derived from the investment of money alone.108 The principle behind
this is that money has to be doing work in order for profits to be
made.109 Innovation, cost, and relationships with Islamic scholars are
thus necessary to create new models.110
Shari’a law requires a different strategy for embarking upon a
business transaction than the ordinary profit-maximizing approach. In
an Islamic transaction, an intermediary will buy the item that the
purchaser wants from the seller.111 The purchaser simultaneously agrees
to pay the bank in monthly installments for a price that is greater than
the price the bank paid (the mark-up value).112 Ironically, this mark-up
value is usually similar to the prevailing interest rate.113 The crucial
element of this transaction is that the bank took possession of the item
for a period of time (even if only an instant).114 In addition, if the bank
collects fees because of late payment, the late fee must be donated to a
charity.115 In one example in the United States, in order to avoid a
leveraged buy-out, Crescent Capital Investments, the American
subsidiary to First Islamic,116 purchased Loehmann’s Department
Stores’ assets and leased them back to the company.117 Models have
been developed that are both acceptable under Shari’a law and
Similar maneuvers are required with home ownership because of
the prohibition against using traditional interest-based mortgages to buy
a home.118 A Muslim previously had two options for homeownership:
either perpetually “rent” a house, or buy the house outright.119 A new
method has emerged where a lease-to-own contract is formed, whereby
the buyer pays monthly installments of the principal plus “rent” to an
institution that purchased the home from the seller.120 Predictably, the
amount of monthly “rent” is typically based on the prevailing market
interest rate. Through these installments of “rent,” equity is built up in
the home, and an ownership interest thus accumulates to the “renter.”121
As one might imagine, this looks very much like a conventional
mortgage; but Shari’a law remains observed by the details of the
arrangement.122 Indeed, for purposes of Shari’a compliance the
arrangement is an interest-free mortgage; yet at the same time the “rent”
is based on, and expressed as, a conventional interest rate.123
Compliance with Shari’a law, however, is not as easy as simply
circumventing its rules.124 Many warn, for example, that “calling
fornication ‘making love’ doesn’t make it any different;”125 similarly,
“selling pork and labeling it beef” is not compliant.126 Although there is
a huge market opportunity to offer the Islamic community the same
diversity in investment opportunity as conventional systems have, it is a
tremendous undertaking to achieve compliance. It is estimated that the
Middle East investment market is somewhere between $250 and $500
billion.127 These numbers represent a great incentive for the creation of
Islamic compliant products, into which this wealth could potentially be
invested.128 Although daunting, the barriers to entry and the standards
that are required for compliance is worth it.129
The United States government has been open to new types of
financing that allows for the United States to service the Islamic
investment industry;130 however, not only do United States companies
have to comply with Shari’a law, but their undertakings must still be
approved by the United States regulatory system.131 The United States
has been flexible in allowing new types of investing, rationalizing that
the inherent structure is the same as conventional investment
products.132 In 1997, the United Bank of Kuwait proposed that the
United States Office of the Comptroller of the Currency permit a bank to
purchase property on behalf of a buyer and hold legal title to it.133 When
payment of the final lease installment is made, legal ownership is
transferred to the buyer.134 Subsequently in 1999, the United Bank of
Kuwait proposed to allow the bank to acquire assets and resell them to
buyers on an installment basis that allowed the bank to mark-up the
price.135 Both proposals were permitted in the United States based on
the rationale that the buy and sell transaction was, effectively, a single
transaction because they occurred simultaneously.136 Under Shari’a law,
compliance was justified because the transaction was viewed as two
separate transactions.137 Such a transaction was rationalized in two
different ways to fulfill the needs of two disparate cultures.138 The form
of the transaction becomes less important when it is reviewed by the
United States in light of the reasons for the additional transaction.139
The United States considered the proposals equivalent to secured loans
and riskless transactions.140 This flexibility demonstrates that the United
States government perceives the value of investment from the Muslim
community worth the additional cost of compliance associated with
It should be noted, however, that some scholars hold that it is not
possible for a conventional bank to offer truly Islamic products since the
conventional bank’s charters and statutes are not Shari’a compliant.142
Such a situation presents the possibility that the funds are drawn from
earnings that are not Shari’a compliant.143 If the basic charters of the
bank do not comply with Shari’a law, then funds, branches, and
windows cannot be deemed compliant.144 Still, most current Shari’a
scholars think that it is acceptable if other services provided by the
institution are not Islamic compliant.145 These scholars feel that it is
sufficient for compliance to be met when funds are completely
segregated, a Shari’a supervisory board exists, a commitment to Islamic
financial concepts is present, and compliance with the AAOIFI is
adhered to.146 In addition, commingled funds containing both compliant
and non-compliant earnings can be purified and then used for
Shari’apermissible investments.147 Perhaps this is part of the notion that the
Islamic economy cannot isolate itself from the rest of the world.148
Some goes so far as to posit that if the Prophet Mohammed were alive
today, he would find some accommodation to participate in the global
economy.149 Proponents also argue that allowing traditional institutions
to offer compliant products creates more competition which will only
lead to more diligence and care in the quality of the products offered by
everyone in the Islamic market.150
The international reaction to the emergence of this industry is a
strong move towards compliance with the standards in order to serve the
Islamic investment market.151 As exemplified by Mr. Eric Meyers152
who devoted five years to the development of Shariah Capital, a hedge
fund that is in compliance with Islamic law.153 Conventional hedge
funds are based on the elements of risk and speculation and use the
concept of “short-selling” to make high profits.154 Mr. Meyers
encountered problems arising from the Quran’s prohibition against
selling something that you do not own, and its prohibition against risk
and speculation.155 Therefore, in order for a hedge fund to be compliant
with Islamic principles, an alternate financial model needed to be
created. Shariah Capital adapts by screening out and monitoring for
compliant, publicly-traded companies using real-time screening
software, while still keeping with the short-selling concept behind hedge
funds.156 The database software allows for access to all deals transacted
and any intermediary involved.157 This availability of information is
important for the disclosure to the fund manager and Shari’a scholars,
who are able to monitor continued compliance and make sure
transactions are pure.158 Shariah Capital also targets only conservative
risk parameters, as opposed to loose risk parameters.159 Fundamental
strategies have not been changed, yet compliance has been met.160 In
addition, Mr. Meyers has created a web portal that brings together
Western companies with Middle Eastern investors.161 This exists purely
to provide access to information concerning these opportunities, not to
act as a broker.162 Mr. Meyers exemplifies someone who saw the ability
to serve the Islamic market by offering Shari’a compliant products to be
worth the cost of compliance with regulations.
III. SARBANES-OXLEY AND ETHICS IN AMERICAN BUSINESS
The regulations, as set forth by the AAOIFI, were created and
published with the purpose of expanding the market of acceptable
Islamic compliant products.163 More compliant products mean more
Muslim investment.164 Expansion is only possible if companies are
aware of what compliance requires. The atmosphere in which AAOIFI
regulations were standardized is distinguished from the corporate
climate during the time when Sarbanes-Oxley was implemented.
Sarbanes-Oxley was a response to the corporate and accounting scandals
within the United States financial system.165 The collapse of Enron and
other massive accounting frauds demonstrated that the standards of
business needed to be amended and heightened.166 An overarching
principle of Sarbanes-Oxley was to create regulations that would
increase public investor trust and confidence that the laws were being
followed.167 Sarbanes-Oxley denotes itself as “[a]n Act to protect
investors by improving the accuracy and reliability of corporate
disclosures made pursuant to the securities laws, and for other
purposes.”168 Although both Sarbanes-Oxley and the AAOIFI
regulations seek to infuse business with ethics, in the case of
SarbanesOxley it is into pre-existing business models.
In the Islamic investing market, financial institutions zealously
comply with the AAOIFI and its intrinsic ethics in order to become a
valid member of the market place. These companies are submissive to
the requirements set forth by the AAOIFI and do not challenge the
purpose behind the laws. In contrast, financial institutions in the United
States attempt to evade compliance with the requirements of
SarbanesOxley.169 Already enjoying the fruits of the marketplace, United States
companies see compliance with new regulations as an additional burden
and cost.170 The ethics of Sarbanes-Oxley are not otherwise intrinsic in
American corporate culture. Indeed, the ethical component of
SarbanesOxley is seen as superfluous to achieving the Act’s regulatory
objectives. Assuming the responsibility of compliance with the historic
rules of a developing market (Islamic) is considerably more acceptable
for new participants than is the burden of compliance with new
regulations (United States) imposed upon an already-existing market.
Rigid ethical regulations are difficult to implement in a business world
that has long existed without them.
165. Michaels, supra note 8 at 31.
167. Nazareth, supra note 10, at 134.
168. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (codified as
amended in scattered sections of 15 U.S.C.).
169. See Glater, supra note 11.
170. See Cory L. Braddock, Penny Wise, Pound Foolish: Why Investors Would Be
Foolish To Pay a Penny or a Pound for the Protection Provided by Sarbanes-Oxley,
2006 BYU L. REV. 175, 176 (2006).
A. Governance Standards in the United States
The United States’ adoption of Sarbanes-Oxley shares many
similarities with the regulations for Islamic banking set forth by the
AAOIFI.171 The use of supervisory boards to review the appropriateness
of proposed investments has been adopted by conventional American
institutions.172 Shari’a law has seen the wisdom in this for decades as a
means of maintaining compliance with their ethical principles.173 The
board that supervises Shari’a compliance is made up of scholars
qualified to make religious rulings (fatawa) on transactions.174 Such
rulings are binding on the financial institution and trump managerial
authority.175 Western institutions have adopted the idea of a supervisory
board for not just legal compliance oversight but also separate, internal
standards of business ethics.176 This demonstrates how corporate
governance in the United States attempts to integrate ethics into the
United States corporate structure.
The United States adopted auditing standards requiring disclosure
requirements similar to the AAOIFI standards. Recognizing the
insufficiency of its standards after the Enron, WorldCom, and Tyco
troubles, the United States created and adopted the Sarbanes-Oxley Act
of 2002.177 The United States was forced to respond since investor
confidence declined and the environment of corporate fraud was
publicized.178 Sarbanes-Oxley Act, although similar in requirements to
the standards created by the AAOIFI, consists of rules designed to deal
with specific problems that the scandals exposed.179
The motive of Sarbanes-Oxley is to protect investors by allowing
them access to more information that is better regulated to ensure
accuracy.180 Sarbanes-Oxley created regulations applicable to
publiclytraded companies in order to avoid financial failure.181 Title I of the Act
creates a Public Company Accounting Oversight Board (PCAOB) to
oversee the auditing of the company.182 This independent board inspects
public accounting firms.183 This board’s allegiance is to upholding
Sarbanes-Oxley just as Shari’a boards’ allegiance is with Shari’a Law.
Title III of the Act amends Section 10A of the Securities and Exchange
Act of 1934 by strengthening the requirements of a company’s audit
committee.184 Title III mandates certification of financial reports by the
principle executive, making him/her responsible for internal controls and
procedure disclosure.185 Title IV of the Act amends Section 13 of the
Securities Exchange Act of 1934 by adding disclosure requirements
requiring management to prepare an internal control report.186 In
addition, the auditor must opine on management’s assessment.187 This
allows investors to be knowledgeable of the company’s internal
controls.188 The Securities and Exchange Commission (SEC) is required
to review the financial reports.189 Title IV is also comparable to the
internal disclosure requirements of the AAOIFI regulations. Title II
amends Section 10A of the Securities and Exchange Act of 1934 by
adding requirements which establish the independence of the auditor.190
Title II prevents auditors from providing any additional consultation to
the company and prohibits communications between management and
the auditor.191 Title II differs from the AAOIFI standards, which
encourages relationships between Shari’a advisors and the management.
180. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (codified as
amended in scattered sections of 15 U.S.C.).
181. Braddock, supra note 170, at 177.
182. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, §§ 101-09, 116 Stat. 745,
750-72 (codified as amended in scattered sections of 15 U.S.C.).
183. Nazareth, supra note 10.
184. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, §§ 301-08, 116 Stat. 745,
775-85 (codified as amended in scattered sections of 15 U.S.C.).
185. Braddock, supra note 170, at 179.
186. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, §§ 401-09, 116 Stat. 745,
785-91 (codified as amended in scattered sections of 15 U.S.C.).
187. Nazareth, supra note 10.
188. Parker, supra note 179.
189. 15 U.S.C. § 7261(c)(1) (2002).
190. 15 U.S.C. § 78j-1(g)-(i) (2002).
191. 15 U.S.C. § 78j-1(g)(1)-(
) (2002). See also, Braddock, supra note 170, at 178.
B. Comparing Sarbanes-Oxley’s Standards with the AAOIFI’s
The purposes of the Shari’a supervisory board and the PCAOB
created by Sarbanes-Oxley are very similar; however, the relationship
between the board and the company, respectively, are unique. The
mandates of the Shari’a board are to assure compliance with the Shari’a
law and also encourage development of compliant products that work
within the ethical framework set forth by the regulations. This
relationship creates many judgments to be made by the board and
communications between the board and the management. This system
of open communication and oversight is distinct from the PCAOB
board’s role. The PCAOB board is excluded from the company’s
management and is meant to merely implement the rules set forth by the
SEC.192 This environment discourages a relationship and reduces
judgments made by this independent committee.
The goals of Sarbanes-Oxley are comparable to the objectives set
forth in the AAOIFI. The primary purpose of Sarbanes-Oxley is to have
independent people reviewing and monitoring the company.193
Increasing disclosure requirements with an independent board is meant
to eradicate inaccuracies and occurrences of fraud by mandating that
auditors’ allegiance be to creditors and stockholders.194 Sarbanes-Oxley
tries to eliminate the conflict of interest between the auditor and the
management to disclose the truth.195 Sarbanes-Oxley is meant to
increase reliability, and to build investor confidence and ethical
business.196 Investor confidence is a key element of the United States
market, an element that cannot be ignored considering America has the
largest percentage of individual participation globally.197
Maintaining investor confidence was also the main goal in
publishing the AAOIFI.198 Despite the structural similarities and
comparable goals, compliance with Sarbanes-Oxley is resisted199
192. 15 U.S.C. § 78j-1 (2002).
193. Nazareth, supra note 10.
194. Braddock, supra note 170, at 182.
195. Id. at 183 (describing Section 301 of the Sarbanes-Oxley Act as an attempt to
eliminate the conflict of interest between the management and the auditor).
196. Michaels, supra note 8.
197. Nazareth, supra note 10.
198. ACCOUNTING, AUDITING AND GOVERNANCE STANDARDS FOR ISLAMIC
FINANCIAL INSTITUTIONS, supra note 12, at Introduction p. XXVI.
199. See Glater, supra note 11.
whereas AAOIFI standards are voluntarily embraced. Even after the
collapse of Arthur Andersen, Enron, and WorldCom and the revelation
of corruption, the response to Sarbanes-Oxley is to avoid compliance
because it is too costly.200 Rather than comply, companies are opting to
not be listed on the United States stock exchanges.201 Publicly-traded
small capitalization companies and foreign companies, which are listed
on the United States stock exchanges, are considering delisting, and
other companies not currently listed are deterred from listing.202 The
United States public offerings dropped by 300% in 2003, the year
following the implementation of Sarbanes-Oxley.203 The reason
proffered by these companies for avoiding compliance with
SarbanesOxley is that the costs of compliance are too high.204
Currently the focus is on the interpretation of Section 404, which
creates a major source of additional costs for companies in auditing their
internal financial controls.205 Business representatives are demanding
relaxation of the regulations in order to address the enormous costs of
compliance.206 It is argued that Sarbanes-Oxley imposes not only the
monetary cost of auditing but also an increased workload to the
corporate board, which will decrease attention paid to other business
activities as well as lost opportunity costs where funds used for
compliance could have been directed towards other productions.207 It is
estimated that companies will use these business interests to try to resist
the provisions of Sarbanes-Oxley.208 In this regard, it is argued that
Sarbanes-Oxley was an overreaction to the corporate fraud scandals at
Privately-held companies are not required to meet the same
disclosure standards as publicly-held companies.210 Only
publiclytraded companies that list their stock on United States stock market
exchanges or securities associations have the more restrictive disclosure
201. Braddock, supra note 170, at 176.
203. Id. at 197.
204. Id. at 176.
205. Alan Murray, Paulson Walks Fine Line Amid Calls for a Less-Intrusive
Regulatory Scene, WALL ST. J., Nov. 29, 2006, at A2.
207. Braddock, supra note 170, at 190-91.
208. Glater, supra note 11.
209. Nazareth, supra note 10.
210. Braddock, supra note 170, at 176.
standards.211 Therefore, those companies that have gone private have
done so either to avoid the cost of compliance with Sarbanes-Oxley or
because they make use of accounting practices that are not in accord
with Generally Accepted Accounting Principles (“GAAP”).212 This
means that the companies actually became less transparent than before,
the exact opposite environment of what Sarbanes-Oxley
contemplated.213 Whether to avoid the cost of adopting heightened
regulations or to continue unethical business practices, Sarbanes-Oxley
has had the effect of discouraging some companies from maintaining
their public status.214
Unlike the Islamic system where such regulations are part of the
whole business system, Sarbanes-Oxley regulations are both resisted and
avoided. American companies are opposed to added costs to comply
with requirements when their market base is not growing. Such required
standards, however, have proved necessary since about 15% of
companies required to comply with Sarbanes-Oxley admitted to material
weakness in their controls.215 This shows that requiring auditors to
reach an opinion on the quality of controls, although costly, has been an
effective tool in implementing ethics.216 It is also said that there are also
benefits in improved efficiencies, increase in quality of financial
reporting, and better ability to detect and prevent inaccuracies.217 Some
even argue that companies’ stock prices have gone up since compliance
with Sarbanes-Oxley.218 Conversely, those companies that delisted from
the United States exchanges had a decline in their stock price.219
Sarbanes-Oxley’s effectiveness for investor protection is further
demonstrated in the international implementation of similar models of
211. Id. at 196.
212. Id. at 197.
213. Id. at 198.
214. Id. at 176.
215. Parker, supra note 179.
216. Glater, supra note 11.
217. Nazareth, supra note 10.
218. Id. This statement is based on a study conducted by Lord & Benoit that
concluded that companies stock price positively reflected compliance with Section 404.
219. Braddock, supra note 170, at 197. This is as opposed to those companies that
delisted before Sarbanes-Oxley was passed. Id.
220. Nazareth, supra note 10.
The difference between the implementation of Sarbanes-Oxley and
the AAOIFIF standards is that Sarbanes-Oxley is a new standard that is
being applied to old practices. The problem is that, after decades of
functioning with weaker, perhaps unethical governance practices,
Sarbanes-Oxley is an attempt to mandate ethical practices through
enforcement of the law. Companies are forced to factor in the cost of
compliance with Sarbanes-Oxley as a business expense without the
offset of new gains. Hundreds of millions of dollars have to be spent in
order to comply with Sarbanes-Oxley.221 In Islamic finance, those that
enter the market and comply with the regulations at cost, do so with
intentions that this cost will be offset by the gain from the new
Unlike the AAOIFI, which is premised on ethical principles,
American corporate law is based on the enforcement of rules. Rules are
made so that breaking them is easy to prove after the fact through
judicial litigation. Some, including the SEC, have suggested that
shifting the accounting standards to a more objectives-oriented approach
would better serve the interests of ethical business practice.223 This sort
of principle-based system would put judgment in the hands of the
accountants.224 The idea is to have a regulatory framework based on
principles as opposed to rules.225 In the American environment of
litigation, this system has not enjoyed much consideration.226 The
Islamic AAOIFI standards, however, could offer some guidance.
Although both systems are premised on the concept of ethics underlying
the transaction and corporate environment, the principle of ethics is
indistinguishable from the Islamic system; whereas in the American
corporate structure, the principle of ethics is distinct. Where ethics do
not inherently control business practices, rules rather than principles
must govern. Islamic regulations embody ethics as a principle with
which business is run, as opposed to Sarbanes-Oxley under which there
is a dichotomy between the implementation of the rules and the ethics
themselves. In order for the American system to be principles-based,
communication between the advisory board and the corporation must be
encouraged in order to implement the necessary standards and fulfill the
prospective guidance of ethical principles. Transformation from rules to
principles would be a positive step. Ethical principles need to be
inherent in business practices for the chasm between ethics and
corporate law to be eliminated. Merely satisfying the requirements of
legislation does not suffice because it encourages a corporate culture that
backlashes against the rules. 227 Sarbanes-Oxley mandates a new level
of accountability for the American business environment and lays the
legal groundwork for the American business system to transform and
shift toward a regulatory framework based on principles,228 as
exemplified by the Islamic system of finance.
4. Julian Walker , Islamic Growth Means Challenges , 1 ( 2005 ), available at http://www.shariahcap.com/news/images/Arab%20Financial %20Forum%20Islamic%2 0Growth%20Means%20Challenges%20Nov05.doc.
5. HSBC Amanah , Frequently Asked Questions, available at http://www.hsbcamanah.com/hsbc/amanah_banking/faqs#14 (last visited Feb. 1 , 2007 ) [hereinafter HSBC Amanah, Frequently Asked Questions], at Is it true that there are only a handful of Shariah scholars in Islamic banking? .
6. Sheikh Nizam Yaquby , Sharia Requirements for Conventional Banks, available at http://www.islamic-banking.com/aom/shariah/sn_yaqubi.php.
7. JULIE FISHMAN-LAPIN , ISLAMIC INVESTING , STAMFORD ADVOCATE (Apr. 23 , 2006 ), http://www.shariahfunds.com/news/images/The%20advocateIslamic% 20Investi ng%20April%2023rd%202006.pdf .
8. See generally , Adrian Michaels, US Companies Not Ready for Governance Rules Sarbanes-Oxley, FIN . TIMES, LONDON ED., July 13 , 2004 , at 31.
10. See generally Annette L. Nazareth , Keeping SarbOx Is Crucial; Some U.S. Critics Call It Burdensome , But Other Nations are Adopting Similar Laws , BUSINESS WEEK , Nov . 13 , 2006 .
11. Jonathan D. Glater , Here It Comes: The Sarbanes-Oxley Backlash , N.Y. TIMES , Apr. 17 , 2005 at 5.
12. See generally ACCOUNTING, AUDITING AND GOVERNANCE STANDARDS FOR ISLAMIC FINANCIAL INSTITUTIONS (The Accounting and Auditing Organization for Islamic Financial Institutions ed ., June 2004 ). (The foregoing source does not contain consecutive pages. It is formatted in a way such that the first page of each section begins at 1. As a result, cites to this source will follow the following format: [name of source], [name of section], [page number] .
13. Id . at Introduction p. XXVI. See also HSBC Amanah, The Concept, supra note 1. Shari'a is interpreted to mean “the path.” Shari'a scholars refer to the Quran and teachings of Muhammad and apply them to issues of today.
14. Fishman-Lapin , supra note 7.
15. WALKER, supra note 4, at 1. See also Yaquby, supra note 6.
16. HSBC Amanah, Frequently Asked Questions, supra note 5.
17. HSBC Amanah, The Industry, available at http://www.hsbcamanah.com/hsbc /amanah_banking/the-industry (last visited Feb. 2 , 2007 ) [hereinafter HSBC Amanah, The Industry] .
18. WALKER, supra note 4, at 1. See also Yaquby, supra note 6.
19. Interview by Paul McNamara with Eric Myers, Islamic Finance On the Alternative Investment Market , ISLAMIC BUSINESS & FINANCE, Dec . 2005 , at 41.
20. Useem , supra note 3 . The Islamic Development Bank is basically an interestfree version of the World Bank . Id.
21. Id .
22. Id . See also WALKER, supra note 4 , at 1; HSBC Amanah , The Industry, supra note 17.
23. WALKER, supra note 4, at 1.
24. Id . $400 Billion is more than four times as much as their account surplus in 2002 . Id.
25. Id .
26. HSBC Amanah, Frequently Asked Questions, supra note 5, at Why is there a need for a separate brand for HSBC Amanah?
27. Karen Iley and Mona Megalli, Western Banks Eye Billion Dollar Islamic Market , REUTERS NEWS, Aug. 8 , 2002 .
28. Useem , supra note 3.
29. HSBC Amanah, The Concept, supra note 1 . In 2002 it was estimated that $100 billion was invested in Islamic compliant products . See also Iley and Megalli, supra note 27.
30. WALKER, supra note 4, at 2. See also McNamara, supra note 19 , at 41.
31. See FISHMAN -LAPIN, supra note 7.
32. See generally ACCOUNTING, AUDITING AND GOVERNANCE STANDARDS FOR ISLAMIC FINANCIAL INSTITUTIONS , supra note 12.
33. HSBC Amanah, Frequently Asked Questions, supra note 5, at What is the purpose of Islamic financial providers?
34. Id . at What constitutes Riba? The prohibition is based on religious beliefs of the teachings of Prophet Mohammad set forth in the Quran. “Any amount, big or small, over the principal, in a contract of loan or debt is 'riba' by the Quran, regardless of whether the loan is taken for the purpose of consumption or for some production activity .” Id.
35. Id . at Why has Riba been prohibited by Islam?
36. Michael J.T. McMillen , Islamic Shari'ah-Compliant Project Finance: Collateral Security and Financing Structure Case Studies, republished from 24 FORDHAM INT'L L.J . 1184 , 1184 n. 2 ( 2001 ).
37. Useem , supra note 3.
38. See ACCOUNTING , AUDITING AND GOVERNANCE STANDARDS FOR ISLAMIC FINANCIAL INSTITUTIONS , supra note 12, at Accounting p. 26 .
39. Useem , supra note 3.
40. Id .
41. Id .
42. Id .
43. Id . The cutoff of debt-to-market-capitalization and cash and interest-bearing securities is a ratio of 33%, and a 45% cut-off is applied to the accounts-receivable-toassets ratio . Id.
44. Id . See generally Iley and Megalli, supra note 27 . See also Dow Jones Islamic Fund, available at http://www.investaaa.com/cgi-bin/client_product. cgi?member=55& product_id=525 (last visited Feb. 6 , 2007 ).
45. Useem , supra note 3 . For example, the Dow Jones Islamic Index would screen out: Marriott, since it serves pork in its hotel restaurants; Citigroup, because of the interest element to their company; and AOL Time Warner, because of the “unwholesome” music and entertainment they support .
46. Dow Jones Islamic Fund, supra note 46.
47. Useem , supra note 3.
48. Id . This donation of dividends to charity is known as “portfolio purification .” Id.
49. United Nations Conference on Trade and Development , Islamic Finance and Structured Commodity Finance Techniques: Where the Twain Can Meet at 3 (May 29 , 2006 ), available at http://www.unctad.org/TEMPLATES/Page.asp?intItemID=3830& lang=1# (follow the link to article).
50. Useem , supra note 3.
51. William Rutledge , Executive Vice President, Federal Reserve Bank of New York, Regulation and Supervision of Islamic Banking in the United States (Apr. 19 , 2005 ), available at http://www.newyorkfed.org/newsevents/speeches/2005/rut050422 .html.
52. Dow Jones Islamic Fund, supra note 44 , at Overview.
53. Humayon A. Dar and John R. Presley , Lack of Profit Loss Sharing in Islamic Banking: Management and Control Imbalances, at 4 (Department of Economics , Loughborough University, Working Paper No. 00 /24), available at http://www.lboro.ac.uk/departments/ec/Reasearchpapers/2000/00-24/erp00- 24 .pdf (last visited Feb. 6 , 2007 ).
54. Useem , supra note 3.
55. Id .
56. HSBC Amanah, Frequently Asked Questions, supra note 5, at Why has riba been prohibited by Islam?
57. Id . The discussion on risk sharing, fair dealing, and equity represents fairness in terms of finance and social justice . See also Useem, supra note 3.
58. Dar and Presley, supra note 53, at 17.
84. Id . at Accounting p. 494 .
85. Id . at Governance p. 5 .
86. Id . at Accounting p. 500 .
87. Id . at Governance p. 5 .
88. Id .
89. FISHMAN-LAPIN , supra note 7.
90. Id .
91. United Nations Conference on Trade and Development, supra note 49 , at 5.
92. FISHMAN-LAPIN , supra note 7.
93. Clare Woodcraft , Shariah Compliant Hedging- Thinking Out of the Box, Shariah Capital, Jan. 15 , 2003 , available at http://www.shariahfunds.com/news/popup.php? cat=show&id=68 (last visited Feb. 6 , 2007 ).
94. ACCOUNTING, AUDITING AND GOVERNANCE STANDARDS FOR ISLAMIC FINANCIAL INSTITUTIONS , supra note 12, at Auditing p. 4 .
109. Id .
110. Yaquby , supra note 6.
111. Useem , supra note 3 . This type of transaction is called a “marabaha .” Id.
112. Id .
113. Id .
114. Id .
115. Id .
116. Barney Gimbel , Loehmann's New Order Keeps the Faith, CNNMoney .com, Feb. 7 , 2005 .
117. Id .
118. See Lornett Turnbull, Faith and Finance Collide for Muslim Home Buyers, THE SEATTLE TIMES , Mar . 21 , 2005 at A1.
119. Id .
120. Id .
171. Rutledge , supra note 51.
172. Id .
173. Id .
174. HSBC Amanah, Frequently Asked Question, supra note 5 , at § B ( noting that more then 15 scholars sit on the Shari'a board for the AAOIFI) . See also Yaquby, supra note 6.
175. Yaquby , supra note 6.
176. Rutledge , supra note 51.
177. Braddock , supra note 170, at 175 ( noting that Sarbanes-Oxley is also referred to as the Public Company Accounting Reform and Investor Protection Act of 2002 ).
178. Id .
179. Andrew Parker , Top Regulator's Tough Sympathy, FIN . TIMES, LONDON ED., Nov. 3 , 2005 , at 14.