Business Ethics in Islam

Al Hud (Hud)
Chapter 11: Verses 84-85

Business Ethics
"To the Madyan people (We sent) Shuaib, one of their own brethren: he said: "O my people! Worship Allah: you have no other god but Him. And give not short measure or weight: I see you in prosperity, but I fear for you the Penalty of a Day that will encompass (you) all round. "And O my people! give just measure and weight, nor withhold from the people the things that are their due: commit not evil in the land with intent to do mischief."

Prophet Shuaib was sent among a people who were very much involved in business. These people were very proud of their business knowledge and success, but they were dishonest. He told them to observe ethics in business. They became very angry with him and told him, "Don't mix religion with business." The Qur'an tells us that Allah's punishment came upon those people and only Prophet Shuaib and his followers were saved.

It is indeed serious that everyone must adhere to ethical standards in business. Business and ethics are not separate, rather they are interconnected. Prophet Muhammad (peace and blessings be upon him) was an ideal human being in every respect. He was a very honest and successful businessman.

Prophet Muhammad gave many teachings on business and economic issues, he covered almost every aspect of business and economics. Here are only a few major principles of fair business dealings according to Islam.

1. No fraud or deceit, the Prophet is reported to have said, "When a sale is held, say, �There's no cheating�" (Al-Bukhari).
2. Sellers must avoid making too many oaths when selling merchandise. The Prophet is reported to have said, "Be careful of excessive oaths in a sale. Though it finds markets, it reduces abundance" (Muslim).
3. Mutual consent is necessary. The Prophet is reported to have said, "The sale is complete when the two involved depart with mutual consent" (Al-Bukhari).
4. Be strict in regard to weights and measures. The Prophet is reported to have said, "When people cheat in weight and measures, their provision is cut off from them" (Al-Muwatta '). He told the owners of measures and weights, "You have been entrusted with affairs over which some nations before you were destroyed" (Al-Tirmidhi ).
5. The Prophet forbade monopolies. "Whoever monopolizes is a sinner" (Abu Dawud ).
6. Free enterprise, the price of the commodities should not be fixed unless there is a situation of crisis or extreme necessity.
7. Hoarding merchandise in order to increase the prices is forbidden .
8. Transaction of haram items, such as intoxicants, are forbidden.

Shares that were disallowed in March 2007 analysis

Shares that were disallowed in March 2007 analysis. Explanation is given below. It should be noted that you may consider the rules too strict / not strict enough for yourself:

Company Reason

SNGP E

SSGC E

LUCK E

TELE A & E

POL B

TRG B

PIOC E

JPGL E

PPTA E

AACIL E

HCAR E
ANL E

NCL E

ATRL C

APL B

DAWH B
DANC E

NRL B

PIAA E

BOSI E

NML E

DGKC E

CSAP E

WAZIR E

PNSC B

ATLH E

GTYR E

DSFL E

KOHW E

PCCL E

MTL B

GADT E

CRESCENT TEXTILE B & E

IBFL D & E

Reason Explanation

A Haram Income Ratio should be <5%

B Illiquid to Total Asset Ratio should be > 20%

C Liquid asset per share should be = to or less then the share price

D Investment in Non-Shariah Compliant Business Cap<33%

E Debt to Market Capitalization should be <45%

Most of the disallowed shares are due to reason E. But why Debt to Market Cap is used as opposed to Debt to Total Assets and why 45% and not 33% as in case of Reason D? And it is a bit more relaxed than the criteria posted on Al-meezan web site that was posted earlier (included at bottom of the e-mail). So it is again upto the individual to figure out what he/she feels comfortable with. In the end it is not Taqi Usmani or any other mujtahid who will be responsible. It will be u!!!

Source: A very Good Friend, Meezan Bank Websit

Shariah / Sharya Compliant Trading

In an equity or mutual fund (unit trust) the amounts are invested in the shares of joint stock companies. The profits are mainly derived through the capital gains by purchasing the shares and selling them when their prices are increased. Profits are also earned through dividends distributed by the relevant companies. From this angle, dealing in equity shares can be acceptablein Shariah subject to the following conditions:

1. The main business of the company does not violate Shariah. 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 Shariah, eg. companies manufacturing, selling or offering liquor, pork, haram meat, or involved in gambling, night club activities, pornography, prostitution, or involved in the business of hire purchase or interest etc.

2. If the main business of these companies is halal, like automobiles, textile, 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 or non-Halal activities is included in the income of the company, the proportion of such income should not exceed 5% of the total income. If it exceeds 5%, it is not permissible to invest in that company. However, if it does not exceed 5%, it must be given in 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 in charity. Moreover, the company's total short term and long term investment in non-permissible business should not exceed 30% of the company's total market capitalization.

{It may be questioned "What is the basic rationale of this limitation of 5%?" Infact, there is no specific basis derived from the Holy Quran or Sunnah for the 5% rule of non halal (impermissible) income. However, this is only the collective outcome (consensus) or ijtihad
of contemporary Shariah Scholars. To explain this consensus of their ruling, we shall have to go back to the origin or basis of company on Shariah perspective. As mentioned in the books and research papers of Islamic jurists, companies come under the ruling of Shirkatul Ainan. But if the rule of partnership is truly applied in a company, there is no possibility for any kind of impermissible activity or income. Because every shareholder of a company is a sharik (partner) of the company, and every sharik, according to the Islamic jurisprudence, is an agent of the other partners in matters of 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 shareholder that the company is involved in an un-Islamic transaction, and he continues to hold 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.

However, a large number of Shariah Scholars say that Joint Stock Company is basically different from a simple partnership. In partnership, all the policy decisions are taken through the consensus of all 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 majority takes the policy decisions in a joint stock company. Being composed of a large number of shareholders, 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 shareholder 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 that he has given his consent to that transaction in his individual capacity, especially when he intends to refrain from the income resulting from that transaction. Therefore, if a company is engaged in a halal (permissible) business, but also keeps its surplus money in an interest-bearing account, wherefrom 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, then it cannot be said that he has approved the transaction of interest and hence that transaction should not be attributed to him. In short, the matter of traditional partnership is different from the partnership of company in this aspect. Therefore if a very small amount of income is earned through these means despite of his disapproval, then his trade in shares would be permissible with the condition that, he shall have to purify that proportion of income by giving it to charity. Now a question could be raised as to what extent or what limit that income would be forgone. Definitely, this matter could not be left on decisions or opinions of lay men, therefore, it was resolved through the consensus of proficient Shariah Scholars that the limit of impermissible income should not exceed 5% of the total income}

4. The leverage or debt to equity ratio of the company should not exceed 30%. To explain the rationale behind this condition, it should be kept in mind that, such companies sometimes borrow money from financial institutions that are mostly based on interest. Here again the afore mentioned principle applies i.e. 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, even though according to the principles of Islamic jurisprudence, borrowing on interest is a grave and sinful act, for which the borrower is responsible in the Hereafter; but, this sinful act does not render the whole business of the borrower as Haram (impermissible). It is explained in the conventional books of Islamic jurisprudence that the contract of loan is among those, that are called "Uqood Ghair Muawadha" (Non compensatory contracts), therefore, no void condition such as condition of interest can be stipulated. However, if such a condition has been stipulated, the condition itself is void, but it will not invalidate the contract. Since, the contract remains valid despite of void condition, the borrowed amount would be permissible to use and it would be recognized as owned by the borrower. Hence, anything purchased in exchange for that money would not be unlawful. However, the responsibility of committing the sinful act of borrowing on interest rests on the person who willfully indulges in such a transaction but this does not render his entire business as unlawful. But it should also be remembered that the extent of investment in shares of companies, that involve borrowing should be limited. Can this limit be the same as the 5% limit that is applied to interest income? No, because in this case this activity does not affect the income of the company, it is less severe than interest based income, therefore, Shariah scholars and Islamic jurists extended the limit (from 5% which is limit of interest/impermissible income) to 30%. The basis of 30% is that the 30% is less than one third (1/3rd) of the total asset of the company and one third has been considered abundant by the following Hadith of the Holy prophet (SAW) "One third is big or abundant" (Tirmizy). Hence whatever is less than one third, would be insignificant. Therefore to avoid the majority or abundance specified in the hadith, such limit is fixed at less than one third of the total asset of the company.

5. 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 at 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 warranting 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% in the least. They argue that if such assets are less than 50%, then most of the assets are in liquid form, and 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 thing. Some other scholars are of the view that even if the illiquid asset of a company is 33%, its shares can be treated as negotiable. The basis of this view is a well-known Hadith that means "One third is big or abundant" (Tirmizy).

They say that according to the Hadith one-third illiquid assets will be considered as sufficient or abundant for this purpose. The third view (of the scholars of the sub continent of Pakistan and India) is based on the Hanafi jurisprudence. The principle of the Hanafi School is that whenever an asset is a combination 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:

A. The illiquid part of the combination must not be in insignificant quantity. It means that it should be in a considerable proportion.

B. The price of the combination should be more than the value 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 at 105, it will mean that 75 dollars are in exchange of 75 dollars owned by the share and the balance of 30 dollars is in exchange of the fixed assets. Conversely, if the price of that share is fixed at 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 at 75 dollars, it will not be permissible, because if we presume that 75 dollars of the price are against 75 dollars owned by the share, no part of the price can be attributed to the fixed assets owned by the share. Therefore, some part of the price (75 dollars) must be presumed to be in exchange of the fixed assets of the share. In this 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.

Among the three different views mentioned above, the most conservative view is the first one. Therefore, nowadays that has been adopted by the majority of Shariah boards of Islamic mutual funds or in screening of the Islamic stocks methodology.

Conclusion:

The purchase and sale of shares is permissible in Shariah. 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 are 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'.

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 method of purification adopted by Dow Jones Islamic market Index are in favor of this view.

As we have discussed above for the negotiability of the share, it is essential for the share or securities that they represent more than 55% illiquid assets. If a mutual fund has 10% cash and 90% shares, we shall have to see how much of these shares represent fixed assets. Fixed assets include land, equipment, machinery and leased assets. If these shares represent more than 55% of fixed or illiquid assets, such shares or Musharkah certificates of mutual fund can be negotiated at other than par value as well. Sale of option short sale, future sale and forward sale where some principles of Shariah are lacking are not permissible...