US court dismisses lawsuit about AIG's takaful business

A Michigan court dismissed a case filed against the US government challenging the permissibility of the Federal assistance provide to American International Group (AIG) on the basis that AIG provided Islamic financial products and therefore the assistance violated the First Amendment of the US Constitution, which prohibits the government from engaging in the establishment of religion. The case ultimately revolved around the size of AIG's takaful business, which the Court noted accounted for only 0.022% of total revenues in 2009; the subsidiary which offers takaful in the United States generated 0.0006% of its revenue from that product in 2009. The case was filed on behalf of Kevin Murray, a military veteran, by the Thomas More Law Center, a right-wing Christian legal organization. When I inquired in 2009 after the plantiff's standing to proceed with the case was upheld, Dr. Robert Tuttle, a Professor of Law a George Washington Law School and expert on Establishment Clause cases, expressed doubts that it would succeed.

The Court reviewed the financing provided by the US government to AIG, but excluded $40 billion in preferred shares that were used to repay debt owed by AIG to the Federal Reserve Bank of New York, leaving only the $30 billion extended under the Emergency Economic Stabilization Act (the TARP), of which $7.5 billion had been drawn on by AIG by February 2010. AIG was required to certify the uses of the funds provided by the US government. The plantiffs in the case argued that the AIG bailout was undertaken with the purpose of advancing religion because AIG was provided funds "to support all of its activities" including Islamic finance (takaful).

However, the court decided that the TARP legislation and the AIG bailout was created for a secular purpose (preventing the collapse of the financial system) and relied upon the small share of total revenue generated by Islamic finance by AIG to support its case in this case. The Court also rejected the claim by the plaintiffs that the TARP bill led to the government taking control of AIG, which included its subsidiaries that offer Islamic financial products noting that "the Trust [which holds ownership for the benefit of the Treasury department] was established by actions taken pursuant to Section 13(3) of the FRA [the Federal Reserve Act]--not the EESA [the TARP]". Section 13(3) of the Federal Reserve Act allows the Federal Reserve, which gives the Federal Reserve Banks the power to intervene in unconventional ways under "unusual and exigent circumstances".

In this claim which was based on the government being entangled with AIG's Islamic finance business by virtue of the financing it provided, the plaintiffs argued that the case is similar to the government providing grants to religious organizations and used their expert witnesses to attest to what they consider the insidious aspects of Islamic finance, which the Court found was irrelevant because it did not address AIG's takaful business specifically. The Court also noted that "Plaintiff cannot defeat Defendants' motion for summary judgement, or prevail on its own, but arguing that the evidence in support of his claim is so overwhelming that he need not present any [evidence] to the Court".

In addition, the Court found no evidence to meet the other ways in which the government could be entangled based on AIG's offering of takaful products; in order to do so, the organization would need to be primarily 'sectarian' (i.e. provide a primarily religious mission) or the government funding would have to fund religious teachings directly. In the other claim for excessive entanglement between the TARP funds and AIG's takaful business, the court ruled against the plaintiffs on the basis that the plaintiff's ceded the point by declining to provide evidence and failure to respond to the US government's arguments against their claim.

Finally, the plaintiffs claimed that the Treasury Department had given its stamp of approval to Islamic finance by publishing a paper on by Dr. Mahmoud El-Gamal on Islamic finance, by creating the position of scholar in residence, which was held by Dr. El-Gamal, by having a member of the Treasury Department speak at the Harvard University Forum on Islamic Finance and by holding an "Islamic Finance 101" conference. The Court found that, in addition to those events being held prior to the TARP legislation, they did not "show that the government favorably endorses Sharia-based Islam or religion in general" and that it was permissible for the government to endorse an educational message relating to religion citing previous court rulings permitting using the Bible for the "study of history, civizilation, ethics, comparative religion, or the like".

The case is significant for Islamic finance in the US because it demonstrates that not only did the Islamic finance activities of AIG when it was under majority ownership by the government not pose a threat on grounds of money laundering or the financing of terrorism, it did not violate the establishment clause. The former was not mentioned in the order, even as the Thomas More Law Center, which brought the lawsuit, cited as justification for the lawsuit that "in abetting the spread of Sharia-compliant financing, AIG and the federal government are abetting the same legal system that motivated the murder of nearly 3,000 Americans on 9/11". This case should have been the spotlight for Islamic finance if it were engaged in illegal practices because the plaintiffs were arguing that not only was AIG supporting Islamic finance, but the government was by virtue of its ownership of nearly 80% of the company. However, there was no finding that Islamic finance had led to support of any illegal acts and beyond that, the government's actions did not violate the Establishment Clause.

This won't stop the echo chambers that are the anti-Islamic finance movement from continuing to spread their baseless claim that Islamic finance supports illegal activities including terrorism, but it does discredit their claims substantially. If there were any untoward activities in Islamic finance, this would have been the ideal forum for this group and its supporters to make it. The judge's order did strike at the heart of one of their main "arguments": that non-permissible income that is donated to charity is used to support charities promoting violence or proselytizing. The judge noted in a footnote that Lexington Insurance Company, which offers a "takaful homeoners policy", "a certain percentage of the net surplus, if any, derived from the collection of premiums is paid out to either the National Children's Fund or the International Federation of Red Cross & Red Crescent Societies [...] selected precisely because they lack religious affiliation".

In the best case scenario, this ruling could provide support to US financial institutions involved with Islamic finance, whether or not they received or have outstanding loans from the TARP fund. It demonstrates that the US courts view Islamic finance as "just another business", as they should. It also supports the precedent from the East Cameron sukuk case that Islamic financial products will be judged by US courts on their merits as financial products, and not on the basis of the religious and ethical grounds for their orgination. In my opinion, the Establishment clause is important both because it limits the ability of the government to favor one religion over another, but also because it limits the ability of groups hostile to one religion or another from using the cudgel of litigation to limit the freedom to shape individual's choices based on their religious beliefs, even where these are expressed by demanding products from large financial institutions that may be bailed out by the US government from collapse based on their other business activities. This should be supportive for Islamic finance in the US because it moves the focus--both in the legal and regulatory sense--from the religious arguments to the practical arguments. How does Islamic finance work as a financial product? Is it fair to consumers? How does its structure fit in with the regulations and laws of the US? This is where Islamic finance belongs in its relationship with secular governments and it should also move the discussion among lawmakers and regulators from the "Islamic" aspect to the "finance" aspects.

UPDATE:
The court's ruling is here
The plaintiff's lawyer's long paper on why Islamic finance is a legal risk can be downloaded here

Islamic Finance Advocacy

There have been many attempts to change tax laws in non-Muslim majority countries like the UK, France and South Korea and in some (UK and likely France soon) these have been successful.  But, South Korea's parliament again failed to pass the law with opposition from some Christian lawmakers who fear that recognizing the Islamic restrictions on interest would be against the country's constitution.  I don't know enough (anything) about the South Korean constitution to know whether that is the case, but it is clearly at least to some degree based on a general Islamophobia because opponents also expressed fear that the Islamic financial products could result in funds being funnelled to terrorist groups.

Despite the fact that there is no basis for the belief that Islamic finance supports terrorism (Islamic banks and financial institutions are subject to the same restrictions on funding terrorism and being involved with money laundering), it does highlight the difficulty of expanding Islamic finance beyond the Muslim market.  Similar baseless fears have led to laws banning "Shari'ah" in Oklahoma, which Haider Ala Hamoudi tried to understand on his blog Islamic Law in Our Times.

Some have called for Islamic finance to drop the 'Islamic' part of its name and the use of Arabic terms (which I have criticized on my blog).  This would not do anything to defuse those who believe Islamic finance is somehow a nerfarious attempt to "impose Shari'ah law" in the West.  It is likely that there is nothing that can be done to convince these critics that Islamic finance is either benign or beneficial.  However, these instances where the general public on its own or through politicians take a broad brush to anything 'Islamic' suggest that there is not wide enough understanding about Islam in general or Islamic finance in particular.

I don't have a solution to approach the anti-Islamic finance crowd, but I think that there should be more of an effort by the Islamic finance industry, particularly from institutions outside of Muslim majority countries to become more active in explaining Islamic finance to the general public.  Of course, these institutions are more than willing to explain to potential customers how Islamic finance works, but I think that is not enough.  The industry needs to have some broader outreach to ensure that the dialogue is not defined by the opponents of Islam in general or Islamic finance in particular.

A cursory Google search turns up no Islamic finance advocacy groups.  With all of the resources being applied to developing Islamic finance, particularly outside of the traditional regions where it has thrived like the GCC and Malaysia, it seems problematic that there is no group out there committed to explaining Islamic finance to the public.  There are many spokespeople who can articulate the reasons why Islamic finance exists, how it works and why it is not the threat that some people claim.  However, most of these people simply do not have the time to make a concerted effort to explain it to a wider audience because they are involved in tackling the most pressing issues in Islamic finance.  If Islamic financial institutions truly want to broaden their market beyond Muslims, this should be one of the first things to set up.  However, the benefits will accrue to the industry as a whole, so it is in no one institution's benefits to commit the resources to this important task.  Therefore it is imperative for Islamic financial institutions to work together through an independent group to coordinate activities.

Is the US unfriendly towards Islamic finance?

In general I try to ignore the fringe groups that believe all Islamic finance is terrorist finance, but an editorial in Investors Business Daily (not the first such article in that paper) makes such a specious argument it demonstrates (through hyperbole) why the US (in particular, Wall Street) lags in Islamic finance. The hyperbole comes when the article claims that lobbyists meeting in a Caribou Coffee (owned by Arcapita) are having "tea with terrorists" (as the article's title implies).

The refutation of Islamic finance offering anything more than conventional finance with a different structure to avoid prohibited activities including interest is easy. Zaid Ibrahim & Co covered the misconception that Islamic finance is "terrorist financing" in a short book (available online as a PDF). However, the hostility towards Islamic finance in the US that this type of article demonstrates is hurting the US financial industry's ability to compete in Islamic finance with other countries that are being more supportive: the UK, Singapore, Japan, South Korea, Australia, and France.

The US should be attractive to Islamic finance because of its deep capital markets and Islamic finance should be attractive to the US financial markets because it brings a small but rapidly growing source of capital and investment opportunities that can replace revenue sources lost when the shadow banking system collapsed. One of the differences between the US and other countries listed above is that the governments have come out and indicated their support publicly for attracting Islamic finance by leveling the regulatory playing field (usually with a desire to be a Western 'hub' for the industry).

Despite the hostility towards Islamic finance demonstrated in this article, there are many US financial institutions that are involved in Islamic finance, but they are doing so largely outside of the United States. This is disappointing because the world's financial system is becoming more interconnected and the growing links between countries increases the supply of capital that could be used to finance investment in the US. Ignorant articles that do nothing but make the US seem unfriendly to one source of capital, particularly one which is growing in importance globally is incredibly shortsighted.

Other News

• Indonesia is considering changing the way it issues sukuk, possibly switching from an auction to a book-building structure because of several failed auctions. The auctions failed primarily because investors asked for yields higher than the government was willing to accept to compensate for the illiquidity of the sukuk.
  
• A joint venture between Alcoa and the Saudi Arabian Mining Company are raising financing, in part through Islamic debt, to finance an aluminum smelter.
  
• Bahrain Islamic Bank is raising its capital by 75% following a loss caused by it taking provisions against its investment portfolio.
  
• A bank in Morocco, Attijariwafa Bank, launched an Islamic banking subsidiary, Dar Assafaa.
  

Islamic banking flagging in Egypt, India could be the source of future growth

The lack of demand for Islamic banking in Egypt provides a stark warning for other countries' Islamic finance industry about enforcing adequate supervision & regulation. In the 1980s, many Islamic banks folded, taking the savings of many Egyptians with them. This produces a skepticism of Islamic banks generally among the population. In order to avoid a similar fate, other countries with Islamic banks need to take the utmost care to ensure that their country's Islamic banks are not taking excessive risk which could threaten their survival. One banking analyst in Cairo described the failure of many Islamic banks as "a social crisis," adding that "the image of Islamic banks still is not great"

Islamic banking has an additional challenge: fighting against perceived (and assumed) connections with terrorism through lengthy court battles.

Overlooked until now, India could be the next growth center of Islamic finance.

The Financial Times provides its take on the rapid growth of the sukuk market.