Part II

Introducing Islamic Commercial Law

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In this part . . .

Sharia law spells out for Muslims how they should behave in the world; it illuminates the ethics that should guide their actions. This part features two chapters that home in on those ethics. First, I devote a chapter to Islamic ethics as they apply to commercial pursuits. Then I explain how compliance with sharia guides the development of all Islamic commercial contracts, which in turn influence every Islamic financial product.

Chapter 5

Adhering to Islamic Commercial Ethics

In This Chapter

arrow Recognizing the purpose of business ethics in general

arrow Introducing key Islamic values

arrow Tying key Islamic values to business functions

The topic of business ethics is hot. Unfortunately, that’s because so many business organizations — from small retailers to giant multinational corporations — find making ethical decisions difficult.

Part of the appeal of the Islamic finance industry for Muslims and non-Muslims alike is that it centers on a religion that encourages high ethical standards. As I explain in Chapter 2, sharia is a code of conduct that shows Muslims how to apply Islamic law to all aspects of their daily lives. Because Islamic finance adheres to sharia, the professionals who work for Islamic banks, investment firms, and insurance companies are constantly striving to live up to the ethical standards established by Islamic law.

No Islamic company can claim ethical perfection, of course, but the reality is that a firm can’t claim to be Islamic if it consistently fails to comply with sharia. An Islamic business that doesn’t adhere to the code of conduct set by sharia will quickly lose its customer base and its ability to remain a going concern.

In this chapter, I first spend some time defining the term business ethics. I then turn my focus to Islamic ethics — the values that Muslims are taught to live by — and how this moral code influences the way Islamic financial institutions conduct their business.

remember.epsThis chapter deals specifically with Islamic values as they relate to business ethics. For more on the basic tenets of Islam, flip to Chapter 2.

Considering the Role of Business Ethics

Ethics are moral principles that guide people to do what’s right and avoid doing what’s wrong. Different groups of people define right and wrong differently, which is why ethical standards vary from place to place and culture to culture. Sometimes ethics are written down — in a country’s laws or a culture’s sacred writings, for example — but ethical codes are often unwritten.

Business ethics, then, are rules of conduct that guide people to do what’s right and avoid doing what’s wrong within the context of a business operation. These rules or standards must guide an organization’s actions even when they aren’t spelled out in the particular regulations that apply to the company.

realworldexample.epsConsider a multinational organization, for example, that’s based in an African country where no regulations or laws exist to prohibit child labor. The company can legally recruit children to work and pay them less than what it pays adult workers. By doing so, the company can reduce its operational costs and increase profits. But business ethics guide the company to resist this profitable activity. Among the ethical standards of a multinational organization is a responsibility not to exploit children.

remember.epsNo universal written standard describes how companies and businesspeople should behave. Instead, business ethics are developed and applied during actual business operations. As a result, ethical standards often vary from industry to industry.

Because business ethics cover so many areas of operation, ethical violations in the business world can take a seemingly infinite number of forms. Here are just a handful of possibilities:

check.png A company may engage in fraudulent billing, which means it bills customers for services they didn’t receive.

check.png A corporation may knowingly create fraudulent documents, such as financial statements to secure a bank loan.

check.png A business may disclose personal information about its customers to marketing firms in exchange for compensation from those firms.

check.png Senior-level managers may receive bonuses when pay and/or benefits are reduced for lower-level employees.

I could add topics such as air and water pollution, hazardous working conditions, unpaid overtime, employee intimidation, misleading marketing and advertising, nepotism, hidden assets . . . you get the picture.

realworldexample.epsSometimes ethical concerns arise as a result of one company’s relationship to another. Apple, for example, has enjoyed a pretty positive public image as a company that values innovation and promotes creativity and camaraderie among its staff. But in early 2012, Apple received some biting negative press because of working conditions in the Chinese manufacturing facilities of Foxconn, one of Apple’s contractors. When reports of health and safety violations and mandatory unpaid overtime surfaced, Apple hired the nonprofit Fair Labor Association (FLA) to conduct an independent audit of working conditions in the Foxconn plants that manufacture products such as the iPad and iPhone. To assure its U.S. customers that it takes ethical issues seriously, Apple agreed to address the FLA’s concerns at this contractor’s facilities.

A Quick Primer on Islamic Values

As I explain in Chapter 2, Islamic law (sharia) is a complete code of conduct that governs every aspect of life. The primary sources of sharia — the holy Quran and the sunnah (every teaching of the Prophet Muhammad [pbuh]) — set a high bar for moral behavior and ethical standards that Muslims are expected to meet. Islamic scholars advocate also considering the practices of the companions of the Prophet Muhammad (pbuh) when studying Islamic ethics; such practices are documented in hadith (compilations of the commands, actions, and speech of the Prophet [pbuh]) and in other historical books and records.

Supporting any system of ethics are values: meaningful ideas that are important to individuals, organizations, and/or society in general. For example, an individual worker may value justice for her colleagues in the workplace. An organization may value hard work and teamwork.

Both values and ethics are related to creating a sense of what is right and wrong. When you’re in the midst of a stressful situation (such as a business or personal crisis), that’s usually the wrong time to try to figure out what values and ethics you need to adhere to. (You may find yourself making compromises that hurt you in the long run.) Instead, each individual, company, and society should spend time (ideally during times of peace and neutrality) defining crucial values and ethics that can guide them in good times and bad.

Secular countries derive their value systems from experience and (perhaps) some aspects of religion. Other countries take their cultural values primarily from religions, such as Judeo-Christianity, Buddhism, Hinduism, or Islam.

remember.epsIslamic business ethics are derived from Islamic values. So before I discuss Islamic commercial ethics, I first introduce you to some of the broader values that support them. Note that in Chapter 2, I describe many aspects of Islam, including the core beliefs, obligations, and objectives of its adherents. The values I discuss in this section are built upon these beliefs, obligations, and objectives; you can consider them outward expressions of the tenets I introduce in Chapter 2. As such, these values are often front and center in discussions among leading stakeholder groups in Islamic finance institutions, including boards of directors and sharia boards.

Islamic values aren’t simply nice theories that Muslims consider lofty ideals; they are part of the everyday efforts and conversations in Muslim families, Muslim communities, and Islamic institutions.

Promoting justice and benevolence

Justice is a crucial Islamic value expected from individuals, families, and society in general. In many verses of the Quran, God (Allah) equates the prophets with justice and indicates that the purpose of sending prophets to earth is to establish justice and eradicate injustice in every society. (See Chapter 2 for details on Islamic beliefs about Allah and the prophets.)

Most people can manage to promote justice in normal situations; when times are good, most folks want to see everyone getting their fair share, being treated appropriately, and having opportunities to succeed. But when circumstances change and times get tough, justice may be harder to come by. That’s because an individual’s self-interest may conflict with the larger value of justice. In other words, for the sake of helping himself or his family, someone may knowingly inflict an injustice on others.

Islam requires justice at all times — not just when life is easy. For example, in the Quran (Sura Al-Maeda, verse 8), Allah says, “Let not the enmity and hatred of others make you avoid justice. Be just: that is nearer to piety.” Islam requires justice even when you’re dealing with an enemy.

remember.epsAccording to the Quran and sunnah, a completely just society was established during the time of the Prophet Muhammad (pbuh) and his companions. Every member of society was treated equally; no difference existed between poor and rich, Muslim and non-Muslim, ruler and citizens. (In fact, citizens were able to challenge their leaders in court.)

The concept of justice is very relevant for Islamic businesses. Islamic commercial ethics, which I explain later in this chapter, strive to promote a society in which all the stakeholders of a business are treated justly. Examples of ways in which Islamic financial firms promote justice include the sharing of profit and loss between an Islamic bank or investment firm and its customers, and the sharing of risk among all participants in a takaful (Islamic insurance) fund (covered in Part VI).

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Researching corporate values

Before you accept a job with any large company or institution, you should know what values it professes and make sure they mesh (at least partially) with your own. For example, here are the stated values for Harvard University:

check.png Respect for the rights, differences, and dignity of others

check.png Honesty and integrity in all dealings

check.png Conscientious pursuit of excellence in one’s work

check.png Accountability for actions and conduct in the workplace

Whole Foods includes the following among its stated core values:

check.png Selling the highest quality natural and organic products available

check.png Satisfying and delighting our customers

check.png Supporting team member happiness and excellence

check.png Creating wealth through profits & growth

And Shell sums up its core values this way: “honesty, integrity and respect for people.”

Curious about how a particular company states its values? Just search the company name and “core values,” or crack open the company’s most recent annual report.

Being stewards of the earth

In Islam, humans are considered the stewards of God (Allah). Allah made humans (and only humans) the trustees of this planet so we can manage its resources in thoughtful and useful ways. In return, we are answerable to Allah about our stewardship of the earth. Humans are responsible for protecting, beautifying, and creating harmony — we are not permitted to destroy the earth.

realworldexample.epsIn recent years, many Muslim environmental organizations have emerged all over the world to uphold this value. For example, the Muslim Green Team based in the United States asserts that its goal is “to educate and equip the Muslim community to live greener lives, and to demonstrate to the general public the Islamic environmental message.”

remember.epsIslamic economics comes into play here because managing the earth’s resources wisely is not just a religious value; it’s an important economic activity. Many types of economies have been created based on the management of resources. (Capitalist and socialist economies, for example, take differing views of how resources should be distributed.) Islam allows for a free market economy, but it insists that such an economy must operate with justice and fairness, as well as with an eye toward achieving wise stewardship of the earth’s resources.

Moderating consumption

Islam is a religion that encourages moderation in everything and rejects extremism. Islam requires that Muslims strive for balance in their lives, and that includes balance related to the accumulation of wealth.

Being a miser — that is, resisting spending money on yourself, your family, or your community — is not an acceptable character trait according to Islam. A hadith recorded in the book Sahih Al Muslim, for instance, puts it this way: “Abu Omamah reported that the Messenger of Allah said: O son of Adam! That you spend wealth is good for you and that you withhold it is bad for you, and you should not be backbited for miserliness. Begin with those who are in your family.”

Islam also prohibits extravagant lifestyles. Islamic scholars note that extravagance has two different meanings:

check.png Excessive spending on lawful things: No law in Islam states a specific spending limit; defining the word excessive depends on the specifics of an individual’s life or an organization’s situation.

check.png Spending on unlawful things: Any expenditure on an unlawful good or activity — such as liquor, prostitution, or gambling — is extravagant and not acceptable in Islam.

A key idea that regulates consumption is the avoidance of waste. Extravagant spending is considered wasteful, but using money to purchase lawful things in moderation is considered a positive thing. Consider a verse from the Quran (Sura Al-Araf, verse 31); Allah says, “O children of Adam! Wear your beautiful apparel at every time and place of prayer: eat and drink: but waste not by excess for Allah loveth not the wasters.”

Developing positive characteristics

Islamic teachings specify that true Muslims should have characteristics of trustworthiness, sincerity, honesty, and integrity in all aspects of life. These characteristics can be exhibited first when worshiping God (by being truthful with God, for example) and then by behaving appropriately in every aspect of life — from personal situations to corporate-level transactions. Islam expects a Muslim and an Islamic business not to cheat, falsify information, or lie.

Clearly, Islamic business ethics are greatly influenced by these religious and cultural values. Business transactions in Islamic firms must be based on honesty, truthfulness, sincerity, and integrity. Following these traits in every business transaction helps to develop fair trading practices in society at large, and companies that adhere to them are better able to meet their social responsibilities.

Helping and caring for others

Islam encourages Muslims to behave in socially responsible ways by always considering the welfare of others and of society at large instead of focusing purely on self-interest. This value is quite practical because humans are an interdependent species. Islam recognizes that much of life’s greatest happiness arises when people in our communities are supported and cared for.

Helping can take the form of participating in charitable activities or promoting humanitarian efforts. A Muslim can help her own family, her neighbors, people at risk in her community (such as orphans and the elderly), her society (such as her city, region, or nation), and humankind as a whole.

remember.epsThe Islamic value of helping others is one of the most important for an Islamic financial institution, especially when deciding what types of socially responsible activities to engage in. For example, an Islamic bank considers its responsibility to help and care for others when allocating money for charitable activities and giving qard hasan — interest-free loans — to, say, customers who need emergency assistance, staff members who need help, or the needy in support of starting up small businesses.

The takaful (Islamic insurance) industry is also largely based on this value because its products are based on the concepts of shared risk, mutual responsibility, mutual protection, and solidarity (see Chapter 18). Islamic financial institutions also can’t penalize customers who default on contractual payments due to genuine hardship; the firms cannot impose high fines in that circumstance, for example.

Connecting Islamic Values to the World of Commerce

The modern development of Islamic commercial ethics coincides with the development of the Islamic finance industry (which I outline in Chapter 3). However, the origins of Islamic commercial ethics date back to the early days of Islam; the Prophet Muhammad (pbuh) was a trader, and his trading activities were based on Islamic values.

Islamic commercial ethics are based on the values I outline in the preceding section, and they guide Islamic firms to take morally correct actions. As with conventional business ethics, no universally accepted Islamic standards have been developed. However, the Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI), an international body for setting standards for Islamic financial institutions (see Chapter 4), does put forth standards regarding ethics for accountants and auditors of Islamic financial institutions, as well as for employees.

In this section, I offer an overview of Islamic commercial ethics and point out how these ethics relate to the operations of the Islamic finance industry.

Honoring Islam while supporting material pursuits

Islam isn’t a religion that encourages people to leave society and avoid all involvement in material pursuits and economic activities. Instead, Islam recognizes that humans need material possessions in order to conduct the activities of daily life. People strive to have good houses, reliable vehicles, and so on, and Muslims are encouraged to pursue wealth. In fact, as I explain in Chapter 2, the pursuit of wealth and property is considered an essential objective in Islamic law (although not as crucial as pursuing faith or religion). Islam doesn’t restrict the accumulation of wealth or the dedication to hard work in pursuit of earning money.

remember.epsHowever, Islam does strive to organize economic activities to make sure that they’re fair and that justice is established in society. As I note earlier in the chapter, Islam guides people to avoid extravagances and abstain from economic activities that are prohibited by sharia.

Insisting on sincere salesmanship

Trading is an important function in Islamic economics. Islam encourages trading while banning riba, which is usury or interest (see Chapter 1). This prohibition is based on the idea that any profits achieved during a trade should derive from the value of the items or services; money itself should not be used to make money.

Islam outlines many moral values that Muslims must observe when they’re involved in trading. Here are two key values:

check.png Honesty: Traders need to be honest when they make deals with potential customers. They must provide full disclosure about the product or service being offered, including both its benefits and its faults (if any exist). So if a Muslim is selling a used car, for example, he must tell you the truth about whether it’s been in an accident, whether it’s a gas guzzler, and so on. Similarly, if an Islamic bank is offering a customer an investment account, the bank must be honest about both risks and potential returns based on the information the bank has available. (The bank may be wrong about the investment’s performance, of course, but it must share what it knows.)

check.png Transparency: Closely related to the value of honesty is the value of transparency in trading situations. Being transparent as a trader means sharing complete information with the customer — not just the information that’s most likely to secure the sale. For example, a company or individual can’t name a price that masks hidden fees or service charges that the customer will later face.

Advertising in socially responsible ways

Just about anyone trying to sell a product or service uses advertising, which can be really helpful when a company shares information with the public about a product or service that has the potential to increase quality of life. But the bad side of advertising arises when a company’s focus is so squarely on making money that it neglects to honor the key trading values of honesty and transparency — or it makes an unnecessary or potentially harmful product or service seem appealing.

realworldexample.epsTake tobacco, for a worst-offender example: Decades ago, cigarette ads ignored the health perils associated with smoking. Later, cigarette ads in many Western countries were required to list those dangers, but the ads sought to overcome the health stigma by making smoking seem sexy and fun. (Today’s restrictions on cigarette ads in the United States and other nations have radically changed their nature; you’d be hard-pressed to find the equivalent of the Marlboro Man or cartoon camel these days.)

Of course, ethical standards differ based on the culture, country, or regulatory environment of a business, but corporations play with fire when they create misleading advertisements; if consumers recognize that a company is trying to deceive them, the fallout can undermine sales and destroy customer loyalty. Yet many companies still roll the dice by stretching the truth or avoiding full disclosure in order to get customers in the door.

But in the world of Islamic commerce, socially responsible advertising is becoming the norm. Islamic marketing is a very young and specialized area that hasn’t yet been extensively researched or documented, but I predict that you’ll hear much more about this field in coming years. Here are some of the key concepts at play in Islamic marketing:

check.png Sticking to the truth: Islamic scholars emphasize that advertising should not be based on deception or false information. Instead, advertisers need to disclose the reality of the product being offered. A consumer must be able to easily determine the pros and cons of making the purchase.

check.png Avoiding inflated product pricing: Advertising increases the cost of a product or service because businesses generally add advertising expenses onto retail prices. Islamic scholars encourage companies to limit their ad buys and make them as cost-effective as possible to avoid overly inflated prices.

check.png Playing nice with competitors: Advertisements that criticize or condemn other products unjustly aren’t allowed per Islamic commercial ethics because they violate the Islamic value of justice. Producing this type of ad is harmful to other businesses and is therefore unethical.

check.png Discouraging extravagance: Some advertising encourages people to overspend or to purchase items that are prohibited by sharia. Obviously, an Islamic firm can’t advertise items that are harmful to society and/or are prohibited by sharia, such as alcohol and tobacco. But Islamic firms also should not encourage customers to be extravagant and spend beyond their means. Each company must determine how this limitation applies to its specific offerings.

remember.epsAs I explain in Chapter 16 and elsewhere in the book, Islamic financial institutions are monitored by sharia boards. One task of a sharia board is to make sure that the Islamic firm is socially responsible when advertising its products and services. Also, when Islamic funds select companies in which to invest money, they should screen to eliminate conventional advertising companies that are involved in unethical advertising. See Chapter 12 for a thorough explanation of how Islamic investment funds conduct screenings.

Searching for ethical market mechanisms

The term market mechanism refers to how buyers and sellers use money to ensure a proper allocation of resources. In the market mechanism of a free market, for example, the prices of the goods and the quantities to be produced are decided by supply and demand factors. In theory, capitalism is based on a completely free market — one that has no interference from any other factors except those relating to supply and demand. (In reality, sometimes a government interferes to organize the capitalistic market.) Conversely, socialist economies are based on decisions made by a central authority and have little to do with supply and demand.

Islamic economics differs from both capitalism and socialism. Islam proposes a version of a free market but encourages and imposes specific ethics that should be followed in the market operations. Specifically, Islam envisions a free-market mechanism that avoids injustice to society and promotes caring for others, honesty, transparency, and other Islamic values.

remember.epsThe ethics of an Islamic market mechanism don’t discard the objective of maximizing profits. Instead, this market mechanism seeks to control profit maximization by making sure that social welfare isn’t sacrificed in the process. (The same is true in reverse: the Islamic market mechanism would not seek to sacrifice an individual’s welfare for the sake of societal welfare.) Basically, Islamic market participants — buyers and sellers — are allowed to maximize their profits as long as no unethical activities are involved. Keep in mind that Islam rejects the artificial creation of demand by hoarding goods or withholding supply by other means.

Seeking a just relationship with employees

In general corporate practices, employee exploitation is common. That’s not to say that companies don’t try to avoid it; many do. But as the example of Apple and Foxconn earlier in the chapter demonstrates, employee exploitation can be an unintended result of a company’s actions (such as, in Apple’s case, ordering mass quantities of products to be produced in a short period of time).

Islamic ethics guide the relationship between employer and employee toward one of brotherhood or sisterhood. The employer is encouraged to actively treat employees with respect and with an eye toward their welfare. Employers can’t be unjust in their payment of wages, for example, or dismissive about employee health and safety concerns.

Regarding wages — a crucial factor in the employee/employer relationship — another hadith in the book Ibn Majah states, “The wages of the laborers must be paid to him before the sweat dries upon his body.”

Respecting sharia prohibitions

As I explain in Chapter 1, sharia prohibits certain transactions and businesses because they’re harmful to society and create injustice and other problems. Following is a quick overview of the four categories of prohibitions and an explanation of how they relate to the Islamic values I describe in this chapter:

check.png Riba (usury): Usury is prohibited in Islam, which means that any trade or transaction agreement based on interest is prohibited and void in the Islamic system. From a values perspective, this prohibition exists because interest creates injustice in society; when it’s used, the rich become richer and the poor are left behind. Also, lending money isn’t of itself a productive economic activity; only the small number of people who hoard money benefit from it.

check.png Gharar (speculative transactions): Gharar relates to transactions based on speculation. Gharar is prohibited because these types of transactions aren’t transparent; one or both parties don’t have complete knowledge about the products or about what to expect.

check.png Maysir and qimar (betting on uncertainties): Both maysir and qimar are forms of gambling transactions. Islamic commercial contracts prohibit these transactions because by their nature the transactions can’t be transparent or just to both parties. In Chapter 18, I explain why the entire takaful (Islamic insurance) industry has developed so that Muslims can avoid participating in conventional insurance, which rests squarely on these kinds of uncertainties.

check.png Prohibited industries: Sharia prohibits certain industries that are harmful to humankind, create inequality and injustice, and generate problems related to morality and ethics. Investing or working in these industries isn’t allowed. On the prohibited list are gambling, pornography, specific food and beverage products, prostitution, illegal drugs, and financial institutions that operate based on interest, speculation, and gambling. See Chapter 11 for a more detailed list.

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