Shariah’s Black Box

Another serious avenue for enforcement which avoids the scienter issue arises under the Investment Advisors Act of 1940 (“Investment Advisors Act”). Fund managers who embrace SCF while ignoring Shariah as a material part of the disclosure will quite likely face serious scrutiny as the SEC and large city and state institutional investors (i.e., government worker pension funds) come to understand the intimacy between the terms “Shariah-compliant”, “Islamic finance”, and even “socially responsible Islamic investing” and the Shariah witnessed in Iran, Saudi Arabia, and Sudan. Indeed, a SCF investment or business which attempts to disguise the “Shariah” and utilize a less emotionally charged term has just added to its exposure exponentially since that would certainly be circumstantial evidence that the putative defendants knew of the dangers of Shariah and sought to minimize them by using a more acceptable public relations-sensitive nomenclature. In other words, the choice to avoid the word Shariah is likely to be a central evidentiary proof at trial on the issue of scienter.

Specifically, investment advisers under the Investment Advisors Act, including those who might otherwise fall within a registration exemption (i.e., the fund manager to an exempt hedge fund or “pooled investment vehicle”), come within its quite broad anti-fraud provisions. Thus, under Rule 206(4)-1:

a. It shall constitute a fraudulent, deceptive, or manipulative act, practice, or course of business within the meaning of section 206(4) of the Act for any investment adviser registered or required to be registered under section 203 of the Act, directly or indirectly, to publish, circulate, or distribute any advertisement:

. . .

5. Which contains any untrue statement of a material fact, or which is otherwise false or misleading.[219]

Rule 206(4)-8, captures the pooled investment fund advisors:

a. Prohibition. It shall constitute a fraudulent, deceptive, or manipulative act, practice, or course of business within the meaning of section 206(4) of the Act for any investment adviser to a pooled investment vehicle to:

1. Make any untrue statement of a material fact or to omit to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading, to any investor or prospective investor in the pooled investment vehicle; or

2. Otherwise engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative with respect to any investor or prospective investor in the pooled investment vehicle.

b. Definition. For purposes of this section “pooled investment vehicle” means any investment company as defined in section 3(a) of the Investment Company Act of 1940 or any company that would be an investment company under section 3(a) of that Act but for the exclusion provided from that definition by either section 3(c)(1) or section 3(c)(7) of that Act .[220]