PRINCIPLE OF SHARIA INVESTMENT

(Research Paper Presented by Mufti Taqi Usmani)

The term ‘Islamic Investment ’ in this article means a joint pool wherein the investors contribute their surplus money for the purpose of its investment to earn halal profits in strict conformity with the precepts of Islamic Shari’ah. The subscribers of the Fund may receive a document certifying their subscription and entitling them to the pro-rata profits actually accrued to the Fund. These documents may be called ‘certificates’ ‘units’ ‘shares’ or may be given any other name, but their validity in terms of Shari’ah, will always be subject to two basic conditions

Firstly, instead of a fixed return tied up with their face value, they must carry a pro-rata profit actually earned by the Fund. Therefore, neither the principal nor a rate of profit (tied up with the principal) can be guaranteed. The subscribers must enter into the fund with a clear understanding that the return on their subscription is tied up with the actual profit earned or loss suffered by the Fund. If the Fund earns huge profits, the return on their subscription will increase to that proportion; however, in the case the Fund suffers loss, they will have to share it also, unless the loss is caused by the negligence or mis-management, in which case the management, and not the Fund, will be liable to compensate it.

Secondly, the amounts so pooled together must be invested in a business acceptable to Shari’ah. It means that not only the channels of investment, but also the terms agreed with them must conform to the Islamic principles.

Keeping these basic requisites in view, the Islamic Investment Funds may accommodate a variety of modes of investment, which are discussed briefly in the following paragraphs.

Equity Fund:

In an equity fund the amounts are invested in the shares of joint stock companies. The profits are mainly achieved through the capital gains by purchasing the shares and selling them when their prices are increased. Profits are also achieved by the dividends distributed by the relevant companies.

It is obvious that if the main business of a company is not lawful in terms of Shari’ah, it is not allowed for an Islamic Fund to purchase, hold or sell its shares, because it will entail the direct involvement of the share holder in that prohibited business.

Similarly the contemporary Shari’ah experts are almost unanimous on the point that if all the transactions of a company are in full conformity with Shari’ah, which includes that the company neither borrows money on interest nor keeps its surplus in an interest bearing account, its shares can be purchased, held and sold without any hindrance from the Shari’ah side. But evidently, such companies are very rare in the contemporary stock markets. Almost all the companies quoted in the present stock market are in some way involved in an activity, which violates the injunctions of Shari’ah. Even if the main business of a company is halal, its borrowings are based on interest. On the other hand, they keep their surplus money in an interest bearing account or purchase interest-bearing bonds or securities.

The case of such companies has been a matter of debate between the Shari’ah experts in the present century. A group of the Shari’ah experts is of the view that it is not allowed for a Muslim to deal in the shares of such a company, even if its main business is halal. Their basic argument is that every share-holder of a company is a sharik (partner) of the company, and every sharik, according to the Islamic jurisprudence, is an agent for the other partners in the matters of the joint business. Therefore, the mere purchase of a share of a company embodies an authorization from the shareholder to the company to carry on its business in whatever manner the management deems fit. If it is known to the share-holder that the company is involved in an un-Islamic transaction, still, he holds the shares of that company, it means that he has authorized the management to proceed with that un-Islamic transaction, In this case, he will not only be responsible for giving his consent to an un-Islamic transaction, but that transaction will also be rightfully attributed to himself, because the management of the company is working under his tacit authorization.

Moreover, when a company is financed on the basis of interest, its funds employed in the business are impure. Similarly, when the company receives interest on its deposits an impure element is necessarily included in its income which will be distributed to the shareholders through dividends.

However, a large number of the present day scholars do not endorse this view. They argue that a joint stock company is basically different from a simple partnership. In partnership, all policy decisions are taken by the consensus of all the partners, and each one of them has a veto power with regard to the policy of the business. Therefore, all the actions of a partnership are rightfully attributed to each partner. Conversely, the policy decisions in a joint stock company are taken by the majority. Being composed of a large number of share-holders, a company cannot give a veto power to each shareholder. The opinions of individual shareholders can be overruled by a majority decision. Therefore, each and every action taken by the company cannot be attributed to every share-holder in his individual capacity. If a shareholder raises an objection against a particular transaction in an Annual General Meeting, but his objection is overruled by the majority, it will not be fair to conclude t hat he has given his consent to that transaction in his individual capacity, especially when he intends to withdraw from the income relatable to that transaction

Therefore, if a company is engaged in a halal business, however, it keeps its surplus money in an interest-bearing account, where from a small incidental income of interest is received, it does not render all the business of the company unlawful. Now, if a person acquires the shares of such a company with clear intention that he will oppose this incidental transaction also, and will not use that proportion of the dividend for his own benefit, how can it be said that he has approved the transaction of interest and how can that transaction be attributed to him?

The other aspect of the dealings of such a company is that it sometimes borrows money from financial institutions. These borrowings are mostly based on interest. Here again the same principle is relevant. If a shareholder is not personally agreeable to such borrowings, but has been overruled by the majority, these borrowing transactions cannot be attributed to him.

Moreover, according to the principles of Islamic jurisprudence, borrowing on interest is a grave sinful act for which the borrower is responsible in the Hereafter; however, this sinful act does not render the whole business of the borrower as haram or impermissible. The borrowed amount being recognised as owned by the borrower, anything purchased in exchange of that money is not unlawful. Therefore, the responsibility of committing a sinful act of borrowing on interest rests with the person who wilfully indulged in a transaction of interest, but this fact does not render the whole business of a company as unlawful.

Conditions for investment in Shares

In the light of the foregoing discussion, dealing in equity shares can be acceptable in Shari’ah subject to the following conditions:

(1). The main business of the company is not violative of Shari’ah. Therefore, it is not permissible to acquire the shares of the companies providing financial services on interest, like conventional banks, insurance companies, or the companies involved in some other business not approved by the Shai’ah, such as the companies manufacturing, selling or offering liquors, pork haram meat, or involved in gambling, night club activities, pornography etc.

2. If the main business of the companies is halal, like automobiles, textiles etc, but they deposit their surplus amounts in an interest-bearing account or borrow money on interest, the share-holder must express his disapproval against such dealings, preferably by raising his voice against such activities in the annual general meeting of the company.

3. If some income from interest-bearing accounts is included in the income of the company, the proportion of such income in the dividend paid to the shareholder must be given to charity, and must not be retained by him. For example, if 5% of the whole income of a company has come out of interest-bearing deposits, 5% of the dividend must be given to charity.

4. The shares of a company are negotiable only if the company owns some illiquid assets. If all the assets of a company are in liquid form, i.e. in the form of money, they cannot be purchased or sold except on par value, because in this case the share represents money only and the money cannot be traded in except at par.

What should be the exact proportion of illiquid assets of a company for the negotiability of its shares? The contemporary scholars have different views about this question. Some scholars are of the view that the ratio of illiquid assets must be 51% at the least. They argue that if such assets are less than 50%, the most of the assets are in liquid form, therefore, all its assets should be treated as liquid on the basis of the juristic principle:

‘The majority deserves to be treated as the whole of a thing’

Some other scholars have opined that even if the illiquid asset of a company are 33%, its shares can be treated as negotiable.

The third view is based on the Hanafi jurisprudence. The principle of the hanafi school is that whenever an asset is a mixture of liquid and illiquid assets, it can be negotiable irrespective of the proportion of its liquid part. However, this principle is subject to two conditions:

Firstly, the illiquid part of the mixture must not be in ignorable quantity. It means that it should be in a considerable proportion.

Secondly, the price of the mixture should be more than the price of the liquid amount contained therein. For example, if a share of 100 dollars represents 75 dollars, plus some fixed assets the price of the share must be more than 75 dollars. In this case, if the price of the share is fixed as 105, it will mean that 75 dollars are in exchange of 75 dollars owned by the share and the rest of the 30 dollars are in exchange of the fixed assets. Conversely, if the price of that share is fixed as 70 dollars, it will not be allowed, because the 75 dollars owned by the share are in this case against an amount which is less than 75. This kind of exchange falls within the definition of ‘riba’ and is not allowed. Similarly, if the price of the share, in the above example, is fixed as 75 dollars, it will not be permissible, because if we presume that 75 dollars owned by that share, no part of the price can be attributed to the fixed assets of the share. In thi s case, the remaining amount will not be adequate for being the price of 75 dollars. For this reason the transaction will not be valid. However, in practical terms, this is merely a theoretical possibility, because it is difficult to imagine a situation where the price of a share goes lower than its liquid assets.

Subject to these conditions, the purchase and sale of shares is permissible in Shari’ah. An Islamic Equity Fund can be established on this basis. The subscribers to the Fund will be treated in Shari’ah as partners ‘inter se’. All the subscription amounts will form a joint pool and will be invested in purchasing the shares of different companies. The profits can accrue either through dividends distributed by the relevant companies or through the appreciation in the prices of the shares. In the first case i.e. where the profits earned through dividends, a certain proportion of the dividend, which corresponds to the proportion of interest earned by the company, must be given in charity. The contemporary Islamic Funds have termed this process as ‘purification’.

The Shari’ah scholars have different views about whether the ‘purification’ is necessary where the profits are made through capital gains (i.e. by purchasing the shares at a lower price and selling them at a higher price). Some scholars are of the view that even in the case of capital gains the process of ‘purification’ is necessary, because the market price of the share may reflect an element of interest included in the assets of the company. The other view is that no purification is required if the share is sold, even if its results in a capital gain. The reason is that no specific amount of the price can be allocated for the interest received by the company. It is obvious that if all the above requirements of the ‘halal’ shares are observed, the most of the assets of the company are ‘halal’, and a very small proportion of its assets may have been created by the income of interest. This small proportion is not only unknown, but also ignorable as c ompared to the bulk of the assets of the company. Therefore, the price of the share, in fact, is against the bulk of the assets, and not against such a small proportion. The whole price of the share therefore, may be taken as the price of the ‘halal’ assets only.

Although this second view is not without force, yet the first view is more precautious and far from doubts. Particularly, it is more equitable in an open-ended equity fund because if the purification is not carried out on the appreciation and a person redeems his unit of the Fund at a time when no dividend is received by it, no amount of purification will be deducted from its price, even though the price of the unit may have increased due to the appreciation in the process of the shares held by the fund. Conversely, when a person redeems his unit after some dividends have been received in the fund and the amount of purification has been deducted there-from, reducing the net asset value per unit, he will get a lesser price as compared to the first person.

On the contrary, if purification is carried out both on dividends and on capital gains, all the unit-holders will be treated at par with regard to the deduction of the amounts of purification. Therefore, it is not only free from doubts but also more equitable for all the unit-holders to carry out purification in the capital gains also. This purification may be carried out on the basis of an average percentage of the interest earned by the companies included in the portfolio.

The management of the fund may be carried out in two alternative ways. The managers of the Fund may act as ‘mudaribs’ for the subscribers. In this case a certain percentage of the annual profit accrued to the Fund may be determined as the reward of the management, meaning thereby that the management will get its share only if the fund has earned some profit. If there is no profit in the fund, the management will deserve nothing, but the share of the management will increase with the increase of profits.

The second option for the management is to act as an agent for the subscribers. In this case, the management may be given a pre-agreed fee for its services. This fee may be fixed in lump sum or as a monthly or annual remuneration. According to the contemporary Shari’ah scholars, the fee can also be based on a percentage of the net asset value of the fund. For example, it may be agreed that the management will get 2% or 3% of the net value of the fund (1) at the end of every financial year.

However, it is necessary in Shari’ah to determine any one of the aforesaid methods before the launch of the fund. The practical way for this would be to disclose in the prospectus of the fund on what basis the fees of the management will be paid. It is generally presumed that whoever subscribes to the fund agrees with the terms mentioned in the prospectus. Therefore, the manner of paying the management will be taken as agreed upon by all the subscribers.