FIN 3103 Corporate Governance Weeks 2 & 3 PDF

FIN 3103 Weeks 2 and 3 Corporate Governance FIN 3103 ETHICS, SHARIA LAW AND PROFESSIONAL QUALIFICATIONS Unit 4 RISK MANAGEMENT FRAUD PREVENTION RISK MANAGEMENT & FRAUD PREVENTION Topics to be discussed: ❖What is risk? ❖What is risk management? ❖Fraud risks within an organization: ❖Fraudulent statements ❖Corruption and bribery ❖Asset misappropriation ❖Prevention controls / measures against fraud include: ❖code of conduct / ethics ❖anti-fraud training ❖criminal back-ground checks for current and prospective employees ❖internal controls 2 RISK MANAGEMENT Risk: the probability or threat of damage, injury, loss, or any other negative occurrence that is caused by external or internal factors, and that may be avoided through pre-emptive action (*pre-emptive action: action done to prevent something from happening) 3 RISK MANAGEMENT Risks in a business organization can stem from a number of sources: financial uncertainty, fraudulent behavior, strategic management errors, accidents and natural disasters, IT security threats, data- related risks The risk management strategies have become a top priority for business organizations Risk management is a 5 step process of: identifying analyzing Assessing / Evaluate mitigation / minimizing/managing & monitoring RISK 4 RISK MANAGEMENT All risk management plans follow these 5 steps that combine to make up the overall risk management process: Risk identification: the business organization identifies risks Risk analysis: the business organization then analyzes the risks and determines the odds of it occurring, as well as its consequences Risk assessment: the business organization then assesses the risk and decides whether the risk is acceptable and whether it is willing to take the risk on based on the business organization’s *risk appetite Risk mitigation: the business organization then develops a plan to mitigate / minimize the risks by implementing specific risk controls Risk monitoring: the business organization then monitors the risk and the risk plan 5 RISK APPETITE Risk Taker 6 RISK APPETITE *risk appetite: the amount and type of risk that the business organization is willing to take on ie: the risks that the organization deem acceptable in order to meet its business objectives / ie: in order to conduct business and make a profit Example: opening a branch of the business in a war zone / politically unstable country. A business organization may take on this risk because it will be extremely profitable (ie: benefits outweigh the risk) Organizations will have different levels of risk appetite depending on their sector, culture and objectives 7 LEVELS OF RISK APPETITE Averse: avoidance of risk and uncertainty is a key organization objective Minimal: preference for ultra-safe options that are low risk and only have a potential for limited reward Cautious: preference for safe options that have a low degree of risk and may only have limited potential for reward Open: willing to consider all potential options and choose the one most likely to result in successful delivery, while also providing an acceptable level of reward and value for money Hungry: eager to be innovative and to choose options offering potentially higher business rewards, despite greater inherent risk 8 FRAUD RISK Fraud: fraud is deliberate act of deception committed with the purpose of securing an unfair or unlawful gain Every business organization faces the risk of FRAUD Fraud results in a loss of revenue for the business organization and can also damage its reputation “In today’s environment, companies of all sizes need to consider the risk of fraud and take proactive measures to help mitigate the risks that they face,” There are three types of fraud risks within an organization: fraudulent financial statements corruption and bribery asset misappropriation (theft) 9 FRAUD There are three types of fraud risks within an organization: fraudulent financial statements corruption and bribery asset misappropriation (theft) Fraudulent financial statements: Financial statement fraud is the deliberate misrepresentation of the financial condition of a business organization by the intentional misstatement or omission of amounts or disclosures in the financial statements to deceive financial statement users Corruption and bribery: bribery is an offence which involves offering something, usually money, to someone in order to gain an advantage, and corruption is an abuse of a position of trust in order to gain an undue advantage Asset misappropriation (theft): Asset misappropriation fraud happens when people (third parties or employees) who are entrusted to manage the assets of an organization abuse their position to steal from it through fraudulent activity It can also be known as insider fraud It include both the theft of company assets, such as cash or inventory, and the misuse of company assets, such as using a company car for a personal trip 10 FRAUD PREVENTATIVE CONTROLS The business organization can introduce preventative controls / ie: measures aimed at preventing or reducing the opportunities for fraud The aim of fraud preventative controls is to: reduce the opportunity of fraud occurring remove temptation from potential offenders 11 FRAUD PREVENTATIVE CONTROLS Preventative controls / measures include: o code of conduct / ethics o anti-fraud training o criminal back-ground checks for current and prospective employees o internal controls 12 CODE OF CONDUCT / ETHICS Code of Conduct/Code of Ethics: Is a set of rules outlining the ethical and professional standards expected of employees in the organization towards customers, suppliers, other employees and the organization The code should clearly set out the rules and the consequences for not following them Example of a clause on a code of conduct: “We discourage employees from accepting gifts from clients or partners. We prohibit briberies for the benefit of any external or internal party.” 13 ANTI-FRAUD TRAINING Employees should be given anti-fraud training Topics should include: ❖definition of fraud ❖how fraud hurts the organization ❖how to identify and report fraud ❖criminal consequences of fraud 14 CRIMINAL BACKGROUND CHECKS The organization should have: criminal record checks for prospective employees and ongoing criminal record checks for current employees 15 INTERNAL CONTROLS Internal controls: policies and procedures put in place in the company to ensure that accounting processes are reliable and to prevent or minimize accounting or financial fraud The company can implement the following internal controls to prevent or reduce accounting or financial fraud: Implementation of a whistleblower program Separation of duties Physical audits Review and authorization of expense reimbursements Safeguarding and reconciliation of petty cash funds Access Controls 16 INTERNAL CONTROLS: WHISTLEBLOWER PROGRAM ❑Whistleblower program: ❑is a fraud hotline or web-based portal ❑so that an employee’s fraudulent or suspicious behavior can be reported anonymously and confidentially (usually by other employees but also by external third parties) ❑This is the most common method of detecting organizational fraud ❑ Research has shown it to be extremely successful in detecting employee fraud ❑Policies and procedures related to the whistleblower program should be well- publicized by management in an effort to promote and encourage its use 17 WHISTLEBLOWER PROGRAM In order to be effective, a whistle blower program should: ❖ensure that *potential whistle blowers understand how the program works ❖be available 24 hours a day and 365 days a year ❖ensure that whistle blowers remain anonymous and confidential as much as possible under the law Potential whistleblowers include employees of the organization and external third parties such as vendors, contractors, and customers. INTERNAL CONTROLS: SEPARATION OF DUTIES Purpose of separation of duties: a single employee should not be in a position to both commit and then conceal fraudulent activities There should be a separation of duties involving: cashier bookkeeper Cashier: is in charge of collecting cash from customers Bookkeeper: records the cash receipts This way one single person can’t take the money from the customer, embezzle it, and cover up the thief with fraudulent bookkeeping 19 INTERNAL CONTROLS: PHYSICAL AUDITS Physical audits include hand-counting cash and hand counting an organization’s actual physical assets (eg: furniture, materials, tools) Physical audits should be conducted regularly: counting cash in sales outlets can be done daily or even several times per day# counting physical assets can be done on an annual or quarterly basis 20 INTERNAL CONTROLS: Review and authorization of expense reimbursements ❑a large number of internal organizational fraud involve employees making a claim for reimbursement of fictitious or inflated business expenses ❑In order to reduce/prevent expense reimbursement fraud, management should ensure that: ❑expense and travel damages policies are communicated to all employees ❑details of expenses to be reimbursed (submitted by employees) such as credit card bills, receipts, telephone bills, etc., should be reviewed and signed-off by the employee’s supervisor and the organization’s finance department 21 INTERNAL CONTROLS: Safeguarding and reconciliation of petty cash funds ❑There should be safeguarding and reconciliation of petty cash funds ❑This can be done by: ❑safeguarding: funds kept in a locked box by one person (petty cash custodian) with limited access to other employees ❑reconciliation: the petty cash custodian must record all disbursements and reconcile them with cash on hand ❑An independent audit of the petty cash fund must be conducted on a periodic basis 22 INTERNAL CONTROLS: ACCESS CONTROLS Access Controls: Controlling access to different parts of an accounting system via passwords, lockouts and electronic access logs Also controlling access to the office building or parts of it by way of security guards, password, PIN code, fingerprint, access badge or iris (eye) login 23 FIN 3103 Unit 5 CFA Professional Standards Outline What is the CFA Program? How does the CFA Institute promote ethics, integrity and professional excellence? Who do the CFA professional standards apply to? What are the requirements in paragraphs A and B in CFA Professional Standard I? How does paragraph A of CFA Professional Standards II define material nonpublic information? What is the definition of an “insider” (or corporate insider)? What is the difference between investment banking and commercial banking? 2 CFA INSTITUTE The Chartered Financial Analyst (CFA) Program is a professional credential offered internationally by the American-based CFA Institute to investment and financial professionals. Although the CFA program began in the United States, it has become increasingly international with many people becoming charterholders (i.e., professionals who have successfully completed the CFA program) across Europe, Asia and Australia. 3 Ethics Quantitative methods Economics Corporate finance Financial reporting and analysis Security analysis Portfolio management 4 Pass all three levels of the CFA Program Have four years (48 months) of qualified work experience (or a combination of education and work experience acceptable by the CFA Institute). Become a member of the CFA Institute Adhere to the CFA Institute Code of Ethics and Standards of Professional Conduct 5 CFA CODE OF ETHICS AND PROFESSIONAL CONDUCT The ethics section of the CFA exam is primarily concerned with compliance and reporting rules when managing an investor's money or when issuing research reports. These rules are set forth in the CFA’s "Standards of Professional Conduct." The Code of Ethics and Standards of Professional Conduct ("Code and Standards") are the ethical benchmark for investment professionals around the globe. It sets forth a series of guidelines that serves as the basis for creating the more specific Standards of Professional Conduct. 6 CFA CODE OF ETHICS Members of the CFA Institute must: 1. Act with integrity, competence, diligence, respect, and in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other participants in the global capital markets. 2. Place the integrity of the investment profession and the interests of clients above their own personal interests. 3. Use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, taking investment actions, and engaging in other professional activities. 7 CFA CODE OF ETHICS Members of the CFA Institute must: 1. Practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the profession. 2. Promote the integrity of, and uphold the rules governing, capital markets. 3. Maintain and improve their professional competence 4. maintain and improve the competence of other investment professionals. 8 FINANCIAL SERVICES INDUSTRY What is the financial services industry? The financial services sector consists of a broad range of businesses that manage money and provide financial advice. ❑Insurance companies ❑Investment banks ❑Commercial banks ❑Financial advisors ❑Stock brokerages 9 STANDARDS OF PROFESSIONAL CONDUCT CFA Standard I – Professionalism A. Knowledge of the Law. Members and Candidates must understand and comply with all applicable laws, rules, and regulations of any government, regulatory organization, licensing agency, or professional association governing their professional activities. B. Independence and Objectivity. Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities. Members and Candidates must not offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another’s independence and objectivity. 10 STANDARDS OF PROFESSIONAL CONDUCT CFA Standard I – Professionalism (continued) C. Misrepresentation. Members and Candidates must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities. D. Misconduct. Members and Candidates must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects adversely on their professional reputation, integrity, or competence. 11 STANDARDS OF PROFESSIONAL CONDUCT CFA Standard II – Integrity of Capital Markets A: Material Nonpublic Information Members and Candidates who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information. 12 STANDARDS OF PROFESSIONAL CONDUCT Material information would include the following: Dividend increase, decrease or omission Quarterly earnings or sales significantly different from consensus Gain or loss of a major customer Changes in management Major development specific to that industry Government reports of economic trends (housing starts, employment etc.) Major acquisition or divestiture Offer is made to tender shares (acquisition) 13 STANDARDS OF PROFESSIONAL CONDUCT Nonpublic The information has not been disclosed to the general public. 14 CORPORATE INSIDER – DEFINITION An "insider" is any person who possesses at least one of the following: Access to valuable non-public information about a corporation (this makes a company's directors and high- level executives insiders) Ownership of stock that equals more than 10% of a firm's equity 15 INSIDER TRADING The Case of Levine, Siegel, Boesky and Milken One of the most famous cases of insider trading on Wall Street made household names of Michael Milken, Dennis Levine, Martin Siegel and Ivan Boesky. In the mid-1980s Boesky made millions of dollars pick out potential takeover targets and invest these companies before an offer was made. 16 INSIDER TRADING When the merger offer came, the target firm's stock would significantly increase and Boesky would sell his shares for a profit. Sometimes, Boesky would buy mere days before an unsolicited takeover bid was made public. The Securities and Exchange Commission found that Boesky had paid Levine and Siegel for pre- takeover information that guided his stock purchases Boesky received a prison sentence of 3.5 years and was fined US$100 million. Although he was released after two years, he was permanently barred from working in the securities industry. 17 INSIDER TRADING Milken became known as the "Junk Bond King" because he made his fortune trading in the high-yield, low-grade bonds, which he nicknamed "junk bonds." Milken was accused of assisting Boesky in manipulating stock prices, of keeping false records, and of defrauding their own clients. He was sentenced to ten years in prison, fined $600 million, and permanently barred from the securities industry by the Securities and Exchange Commission. His sentence was later reduced to two years for cooperating with testimony against his former colleagues. 18 STANDARDS OF PROFESSIONAL CONDUCT CFA Standard II – Integrity of Capital Markets B. Market Manipulation Members and Candidates must not engage in practices that distort prices (i.e., change prices so that they are not accurate) or artificially inflate trading volume with the intent to mislead market participants. 19 What is market manipulation? Market manipulation is the intentional act of artificially increasing or decreasing the price of a security. It is illegal because it is an attempt to interfere with the free and fair operation of securities , commodities or currency markets. 20 MANIPULATION OF FOREIGN CURRENCY PRICES Forex Scandal The foreign exchange scandal (i.e., “forex” scandal) is a financial scandal where banks secretly conspired for at least a decade to manipulate exchange rates for their own financial gain. Market regulators in Asia, Switzerland, the United Kingdom, and the United States began to investigate the $5.3 trillion-a-day foreign exchange market (forex) in June 2013 because of questions raised about the activities of currency dealers. 21 MANIPULATION OF FOREIGN CURRENCY PRICES Citigroup and JPMorgan Chase and U.K.- based Barclays and The Royal Bank of Scotland agreed to plead guilty to conspiring to manipulate prices in the foreign exchange market over the course of five years. Those banks and UBS have agreed to pay a total of $5.8 billion in fines to global regulators as part of the forex market scandal. 22 MANIPULATION OF FOREIGN CURRENCY PRICES Starting in 2007, traders these banks formed what they called “The Cartel” to fix daily foreign exchange prices in currencies such as the dollar and euro so that they’d be able to adjust the movements in currency prices in their favor. They used coded language and group instant message chats on their Bloomberg Terminals to influence daily currency rates in the forex market by either bidding up some currencies or withholding markets in others at the close of business. 23 STANDARDS OF PROFESSIONAL CONDUCT CFA Professional Standard III: Duties to Clients A. Loyalty, Prudence, and Care. Members and Candidates have a duty of loyalty to their clients, and must act with reasonable care and exercise (i.e., use) prudent judgment. Members and Candidates must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests. 24 STANDARDS OF PROFESSIONAL CONDUCT Duty of Loyalty The duty of loyalty requires a financial professional to be completely loyal to his/her client at all times. It also imposes the responsibility to avoid possible conflicts of interest. This means he/she can not take advantage of a transaction with a client for personal gain. Violation of the duty of loyalty may expose the financial professional to a court order to pay restitution and stiff fines. 25 STANDARDS OF PROFESSIONAL CONDUCT Reasonable care Use caution in order to protect the client’s investment. Prudent judgement Use good judgment or common sense in providing investment advice. 26 STANDARDS OF PROFESSIONAL CONDUCT Ponzi Scheme In 1920, Charles Ponzi, an Italian immigrant, began advertising that he could make a 50% return for investors in only 45 days. Ponzi was getting rich as people mortgaged their homes and invested their life savings with him. He was eventually indicted on 86 counts of fraud. Some tens of millions of dollars were invested with him. 27 STANDARDS OF PROFESSIONAL CONDUCT Anatomy of a Ponzi Scheme Operators of Ponzi schemes usually attract investors by offering higher returns that are either abnormally high or unusually consistent. The operator pays returns to its investors from new capital received from new investors, rather than from profit earned from investments by the operator. The high returns encourage investors to leave their money in the scheme, so the promoter does not have to pay out very much in redemptions to investors. The promoter simply sends statements showing how much investors have allegedly earned. 28 STANDARDS OF PROFESSIONAL CONDUCT Bernie Madoff Bernard Madoff was founder and Chairman of the Wall Street firm Bernard L. Madoff Investment Securities LLC. The firm employed Madoff's brother Peter as Senior Managing Director and Chief Compliance Officer, Peter's daughter Shana Madoff as rules and compliance officer and attorney, and Madoff's sons Andrew and Mark. Madoff convinced thousands of investors to hand over their savings, falsely promising consistent profits in return. 29 STANDARDS OF PROFESSIONAL CONDUCT Bernie Madoff Madoff's told investors that his investment strategy consisted of purchasing blue-chip stocks and taking options contracts on them. In reality, his business was an elaborate Ponzi scheme which proved to be the largest fraud in U.S. history. His scam was discovered when after clients requested a total of $7 billion back in returns. Unfortunately for Madoff, he only had $200 million to $300 million in his accounts. 30 STANDARDS OF PROFESSIONAL CONDUCT Bernie Madoff In 2009, Madoff pleaded guilty to 11 charges of fraud, money laundering, perjury, and theft. He was sentenced to 150 years in prison and ordered to repay $170 billion to investors. But few victims have regained all of their losses. Five of Madoff's employees were also found guilty, including his brother Peter who was sentenced to 10 years. His accountant and lawyer is also facing up to 30 years in prison for his role in the fraud. Madoff’s son Mark committed suicide by hanging exactly two years after his father's arrest. 31 BERNIE MADOFF CASE ANALYSIS 1. How did Bernie Madoff get caught? 2. What punishment did he receive? 3. How does his punishment compare to the punishment Mr. Raja in the Satyam case received? 4. How does this punishment compare to the punishment Martin Siegel, Dennis Levine, Ivan Boesky and Michael Milken received for insider trading? 5. Examine the discussion of individualism, utilitarianism, Kantianism and virtue ethics. Was Bernie Madoff’s behavior ethical under these ethical theories? 32 STANDARDS OF PROFESSIONAL CONDUCT CFA Professional Standard III: Duties to Clients B. Fair Dealing. Members must deal fairly and objectively with all clients when providing investment recommendations or taking investment action. Requires Members to treat all clients fairly when providing investment advice (i.e., can’t discriminate). 33 STANDARDS OF PROFESSIONAL CONDUCT B. Fair Dealing When a company to raise funds, it frequently does so by issuing and selling stocks or bonds. An investment bank usually helps in this process by providing expertise and customers to buy the securities. The investment bank usually will form an underwriting syndicate (i.e., group of investment banks) help sell the equity or debt securities to investors. The securities usually are sold to institutional investors who in turn sell the securities to the general public on a securities exchange. 34 STANDARDS OF PROFESSIONAL CONDUCT B. Fair Dealing – Initial Public Offerings (IPO) The first time a company sells shares of its stock to the public, it is called an “initial public offering.” Institutional investors will often purchase large amounts of the stock in the IPO. These large-scale purchases usually have the effect of immediately driving up the stock price. So if the stock price goes up, the institutional investors can make a huge profit when they sell their shares to the general public. 35 STANDARDS OF PROFESSIONAL CONDUCT B. Fair Dealing – Initial Public Offerings (IPO) To prevent unfair advantages to “insiders”, the U.S. Financial Industry Regulatory Authority prohibits member firms, or any persons associated with them, from offering or selling the new issue to any account of a “restricted person.” Restricted persons include: FINRA member firms and their employees; Immediate family members of the employee; and Portfolio managers 36 STANDARDS OF PROFESSIONAL CONDUCT CFA Professional Standard III: Duties to Clients C. Suitability. Members must: Make a reasonable examination of a client’s investment experience, risk and return objectives, and finances (i.e, net worth) before making any investment recommendation. Determine that an investment is “suitable” to the client’s financial situation before making an investment recommendation or taking investment action. 37 SUITABLE ❖Definition? ▪ Right or appropriate for a particular person, purpose, or situation. ❖How should a financial professional determine what are right or appropriate investments for their clients? ▪ Due diligence – perform a thorough investigation of their clients before making investment recommendations. ▪ In other words ask lots of questions to “know what their clients want.” 38 STANDARDS OF PROFESSIONAL CONDUCT What is Suitability? “Suitability” is a legal requirement that an investment strategy must meet the investment objectives of an investor. The suitability rule in the U.S. states that firms and their associated persons “must have a reasonable basis to believe” that a transaction or investment strategy involving securities that they recommend is suitable for the customer. This reasonable belief must be based on the information obtained through the reasonable diligence of the firm or associated person to ascertain the customer’s investment profile. 39 STANDARDS OF PROFESSIONAL CONDUCT Determining Suitability of an Investment Firms and associated persons are required to “Know Your Customer (KYC).” The Know Your Customer Rule requires them to obtain information such as the customer’s: 1. Age; 2. Investment objectives (e.g., retirement, buying a home, child’s education, etc.); 3. Level of investment experience; and 4. “Risk tolerance” (i.e., a customer’s willingness to risk losing some or all of the original investment in exchange for greater potential returns). 40 STANDARDS OF PROFESSIONAL CONDUCT Ridel v. Cassin (suitability case) Plaintiffs Jean-Marc Ridel, his wife Nadine Suzanne Josephine Ridel, and their son Marc H. Ridel sued defendants, Armando Cassin and e3m Investments Inc. Mr. Cassin was licensed investment advisor with for the investment firm e3m Investments Inc. The plaintiffs were Canadian citizens and the defendants were located in Canada. 41 STANDARDS OF PROFESSIONAL CONDUCT Ridel v. Cassin (suitability case) Mr. Ridel signed a new client account form filled out by Mr. Cassin when he opened his investment account. Mr. Ridel opened his account with an investment of $42,000 (U.S.). On the account form under ‘investment knowledge’, Mr. Cassin recorded “good.” This meant that Mr. Cassin believed that Mr. Ridel was knowledgeable about investments. During the trial the court, however, concluded that Mr. Ridel had only “limited” investment knowledge. 42 STANDARDS OF PROFESSIONAL CONDUCT Ridel v. Cassin (suitability case) Mr. Cassin recorded on Mr. Ridel’s account form that his investment objectives were 20% income, 30% short-term, 30% medium term and 20% long term capital gains. Mr. Cassin also recorded that Mr. Ridel had a high risk category of 60%. Mr. Ridel, however, testified that Mr. Cassin never asked him about his investment objectives, risk tolerance or investment experience. 43 STANDARDS OF PROFESSIONAL CONDUCT Ridel v. Cassin (suitability case) When stock market prices dropped considerably, the plaintiffs suffered significant losses. However, at Mr. Cassin’s urging they held onto their investments. The stock marked worsened and the plaintiffs eventually incurred losses of approximately $155,000. In response they filed their lawsuit. 44 STANDARDS OF PROFESSIONAL CONDUCT Ridel v. Cassin (suitability case) An expert witness for the plaintiffs testified that the 60% high risk was unsuitable for Mr. Ridel given his age, limited investment knowledge and his investment objectives. The expert testified that Mr. Ridel’s risk factors should have been 40% low risk, 50% minimum risk and 10% high risk for account. 45 STANDARDS OF PROFESSIONAL CONDUCT Ridel v. Cassin (suitability case) Court concluded that Mr. Cassin (1) bought and sold stocks without the plaintiffs’ permission; (2) invested in high risk technology stocks that unsuitable investments; and (3) adopted inappropriate risk factors. The court ruled that Mr. Cassin did not satisfy the “KYC requirements” and therefore awarded the plaintiffs $396,413 in damages. 46 STANDARDS OF PROFESSIONAL CONDUCT CFA Professional Standard III: Duties to Clients E. Preservation of Confidentiality. Members must keep information about current, former, and prospective clients confidential unless: 1. The information concerns illegal activities on the part of the client; 2. Disclosure is required by law; or 3. The client or prospective client permits disclosure of the information. 47 STANDARDS OF PROFESSIONAL CONDUCT CFA Standard IV – Duties to Employers A. Loyalty In matters related to their employment, Members and Candidates must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge (reveal) confidential information, or otherwise cause harm to their employer. B. Additional Compensation Arrangements Members and Candidates must not accept gifts, benefits, compensation, or consideration that competes with or might reasonably be expected to create a conflict of interest with their employer’s interest unless they obtain written consent from all parties involved. 48 STANDARDS OF PROFESSIONAL CONDUCT C. Responsibilities of Supervisors. Members and Candidates must make reasonable efforts to ensure that anyone subject to their supervision or authority complies with applicable laws, rules, regulations, and the Code and Standards 49 STANDARDS OF PROFESSIONAL CONDUCT CFA Professional Standard V: Investment Analysis, Recommendations, and Actions A. Diligence and Reasonable Basis. Members and Candidates must: 1. Exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions. 2. Have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation, or action. 50 WHAT IS A RESEARCH ANALYST? A research analyst is a person who prepares investigative reports on securities (stocks, bonds, etc). The research conducted by the research analyst is provided to clients (internal and external) to help them make intelligent investment decisions. A research analyst is an expert in a very specific sector. For example, the food and beverage market, healthcare industry, technology industry, pharmaceuticals, or financial services. Research analysts provide customers with guidance on the market. 51 WHAT IS A RESEARCH ANALYST? They have to be skilled in working with numbers because of the financial analysis they perform. But they also have to have good writing to write research reports and have good oral communication skills because not all customers have the time to read their lengthy reports. Accuracy and attention to detail are very important. 52 STANDARDS OF PROFESSIONAL CONDUCT CFA Standard VI – Conflicts of Interest A. Disclosure of Conflicts Members and Candidates must fully disclose all information that could impact their independence and objectivity, or interfere with respective duties to their clients, prospective clients and employer. Members and Candidates must ensure that such disclosures are prominent, are delivered in plain language, and communicate the relevant information effectively. 53 Investment Banking: Salaries 1ST year Associate - $150K-$250K 3rd year Associate - $260K-$500K Vice President - $240K-$1M Director - $400K-$1.5M Managing Director/Partner - $500K-$20M Department Head - $800K-$70M 54 FIN 3103 Week 6-b Professional Standard CISI Outline What is the CISI Program? How does the CISI Institute promote ethics, integrity and professional excellence? Who do the CISI professional standards apply to? What are the requirements in CISI sourcing and allocation of fund Professional Standard I? How does Professional Standards means in UAE Rules and Regulations? What is the definition of an “insider” (or corporate insider)? What is CISI International Security investment? CISI Institute CISI: Chartered Institute for Securities & Investment is a professional body securities, investment, wealth and financial planning professionals. Formed in 1992 by London Stock Exchange practitioners, have a global community of circa 45,000 members in 104 countries. As at last year more than 40,000 CISI exams were sat in 80 countries, 15,000 taken outside the UK. CISI CODE OF ETHICS AND PROFESSIONAL CONDUCT The ethics section of the CISI exam is primarily concerned with compliance and reporting rules when managing an investor's money or when issuing research reports. These rules are set forth in the CISI’s Workbook “UAE’s Financial Rules and Regulations” Is regulatory infrastructure established by Federal Law No. 4 that created the Securities & Commodities Authority (SCA). It covers the SCA’s functions and powers, including the requirements relating to membership and the need for securities and commodities markets in the UAE to be licensed by the SCA. CISI CODE OF ETHICS Professionals within financial services owe important duties to their clients, the market, the profession and society: Professional Conduct Principles: 1-To act honestly and fairly at all times, putting first the interests of clients and customers. 2-To act with integrity in fulfilling the responsibilities of your appointment. 3-To observe applicable law, regulations and professional conduct standards when carrying out financial service activities. 4. To observe the standards of market integrity, good practice, conduct and confidentiality required or expected of participants in markets. CISI CODE OF ETHICS 5-To be alert to and manage fairly and effectively and to the best of your ability any relevant conflict of interest. 6-To attain and actively manage a level of professional competence appropriate to your responsibilities. 7-To decline to act in any matter about which you are not competent unless you have access to such advice and assistance. 8-To strive to uphold the highest personal and professional standards at all times. Class Discussion Discuss the areas that overlap between the CFA and CISI. Which would be more suitable for the UAE and why? The UAE’ Rules and Regulations: Brokers Broker(s): is a person licensed by the Security & Commodities Authority (SCA) to practice the profession of brokerage in the UAE. The license is renewable annually by the SCA. The company’s paid-up capital must not be less than AED 30 million. Brokers can be: 1-Individual must register 2- Ministry of Finance & Central Bank’s Representatives without registration 3- Governments of the Emirates members of the Federation without registration The UAE’ Rules and Regulations: Brokers The ethical requirements for the brokers as: 1. To acquaint the market beforehand with the contents of their advertising campaigns to promote their services, before releasing them to the public. 2. To make internal regulations to ensure the proper selection of their representatives and the monitoring of the good conduct of each of them 3. To report promptly to the concerned authorities any contraventions by their representatives, as a preliminary to disciplinary sanctions being imposed upon them. 4. To give the market’s management the name of any client who has failed to fulfil his obligations. 5. To refrain from executing any purchase or sale order off the trading floor. FIN 3103 Week 7 An Overview Of Islamic Business & Finance CHAPTER OUTLINE Introduction The framework of Islam Objectives of Shariah Muamalat in Islam INTRODUCTION Islam is derived from the root word ‘salam’ : submission and peace Definition of Islam: a)Islam is a submission to Allah’s will b) Islam is a sense of total peace which comes from submitting to the will of Allah Islam is the religion of Allah revealed to Prophet Muhammad Allah states: O you who believe! Enter perfectly into Islam and follow not the footsteps of shaitan. Verily, he is to you a plain enemy. (al-Baqarah: 208) Aqidah, Shariah and Akhlaq form the basis of Islamic teaching and practice SHARIAH The word Shariah literally means “ the straight path” to be followed or “the road to the watering place” “ then we have put you (O Muhammad, peace be upon him) on a plain way of Our commandments. So follow that (Islamic monotheism and its laws), and follow not the desires of those who know not” (Al-Quran, 45: 18). Technically Shariah is a divine code of laws which was revealed to Prophet Muhammad (p.b.u.h), recorded in the Al-Quran and deduced from the Sunnah. It covers all the aspects of life, be it economical, social, political, etc. SYARIAH (ISLAMIC LAW) Primary Sources Sources of Shariah Secondary Sources Education (Tarbiah) SHARIAH Justice (Adalah) Protection of Public Objectives of Shariah Interest (Maslahah al- (Maqasid al-Shar’iyah) Ammah) Religion (Din) Life (Nafs) Intellect (Aql) Family (Nasl) Property (Mal) Main sources of Shari’ah Laws Al- Al-Quran Sunnah Al-Ijma’ Qiyas Primary Sources ❖ Al-Quran is the primary source containing all the fundamental directives and instructions of Allah. Herein are to be found not only directives relating individual conduct but also principles relating to all the aspects of social and cultural life of human being. ❖ Sunnah is what is narrated from the Prophet (p.b.u.h) including his actions, sayings, and tacit approval. In other words, it denotes the way Prophet Muhammad (p.b.u.h), lived his life. “ And whatever the Messenger gives you, take( observe) it and whatever he forbids you, abstain from it” ( al-Quran 59: 7). Secondary Sources cont.. ❖ Ijma or the consensus of scholars signifies the importance of delegated legislation to the Muslim community. ❖ Ijma is considered a sufficient evidence for action because the prophet (p.b.u.h) said: “Muslim will never agree on a wrong matter”. Secondary Sources cont… ❖ Literally Qiyas means measuring ❖ Qiyas also means comparison to establish equality or similarity between two things. ❖ In Usul al Fiqh: Qiyas is the extension of a Shari`ah ruling (Hukm) from an original case (Asl) to a new case (Far`) because the new case has the same effective cause (`Illah) as the original case. ❖ Thus, Qiyas has four elements: – Asl: original case, – Far`: new case, – `Illah: effective cause, – Hukm: ruling Secondary Sources ❖ Qiyas – reasoning by analogy (analogical deduction) – by a single Islamic Scholar ❖ Maslah Mursala: Consideration Public Interest i.e. for general public ❖ Istihsaan (preferability): giving of analogy for a stronger evidence for the Qur’an and Sunnah ❖ Istishab (presumption of continuity): Islamic legal term for the presumption of continuity, where a situation existing previously is presumed to be continuing at present until the contrary is proven. ❖ Urf. (Custom): “recurring practices, which are acceptable to people of sound nature ”. ❖ Sad al Zara’i (Blocking the means): it means blocking the means to evil ❖ Sharh mann qoblana Sharhun Alayna ❖ Qaol Al Sahabi: means an opinion reached by a Sahabah by way of Ijtihad Ijtihad Ijtihad is the process which is used by Islamic jurisprudence (fiqh) to discover secondary divine legislation (laws) regarding the organizing of human life and its diverse relations; or attempting to discover and deduce the Islamic laws and regulations from primary sources like the laws concerning worship, possession of properties, business, judiciary, politics and family affairs...etc. Without the process of Ijtihad, it would be difficult for Muslims to adapt to rapid changes in social, economical and political aspects of life. Maqasid al-Shariah ❖ Ibn Ashur stated that the objectives of Shariah is to preserve order, promote social welfare, prevent corruption, establish justice and maintain stability and harmony. ❖ Imam Ghazali stated that the main Objectives of Shariah or Maqasid shariah is to protect public interest. ❖ Imam Ghazali classified Maqasid shariah into three hierarchy of needs: ❖ Necessities (Dharuriyyat) comprise all the activities and things that are essential for the preservation of five essential elements for good social and individual life and must be protected: faith, life, intellect, posterity and property. Whatever insures safeguarding these fives elements serves the public interest and is desirable. Maqasid al-Shariah ❖ Complements (Hajiyyat) comprise all of the activities and things that are not vital to the preservation of the five objectives of Shariah but really are needed to improve wellbeing of Muslim community such as helping the poor, building Mosque. ❖ Embellishment (Tahsiniyyat) includes activities and things that go beyond the limit of convenience. More specifically, it includes matters that adorn livelihood. Going beyond refinement into self- indulgence is considered mafsada (disutility) for the individual and society at large such as living in luxurious life. This should be avoided. MUAMALAT Muamalat refers to doing business and finance. Muamalat also means mutual dealings such as buying, selling, association, making gifts and donations, lending, debt, contract, etc. Indeed Muamalat are dealings necessary for everyday needs of mankind that have been regulated by Quran and Sunnah. The prophet SAW said : “The truthful and trusty merchant is associated with the prophets, the upright and the martyrs” In al-Quran : …..Allah has permitted trading and forbidden Riba.. (al-baqarah 275) Allah states : O you who believe! Eat not up your property among yourselves unjustly except it be a trade amongst you, by mutual consent. And do not kill yourselves. Surely Allah is Most Merciful to you. (an-Nisa 29) OBJECTIVES OF MUAMALAT IN ISLAM Muamalat regulates all parties to a transaction with the spirit of honesty, justice and brotherhood. To encourage human beings to participate actively in commercial transactions, which eventually may lead them to financial independence and self reliance. To avoid any misunderstanding among the parties in transactions from any form of violence, misappropriation, dishonesty and fraud. To ascertain and enforce the rights and duties of the parties involved in the Muamalat. PROBIHITIONS IN MUAMALAT There are many prohibitions, but these five will make contracts invalid: (i) Producing and selling impure goods; (ii)Producing and selling goods that are of no use therefore of no value; (iii) Riba; (iv) Gharar, i.e. ambiguity or uncertainty; and (v) Maisir (gambling), i.e. anything that involves betting. FIN 3103 Week 8 Philosophy of Islamic Finance and Banking CHAPTER OUTLINE Introduction Philosophy of banking & finance in Islam Characteristics of Shariah Forbidden practices in Islamic finance and banking Impediments of transaction in Islam Philosophy of Islamic Finance and Banking ❖Shariah prohibits riba (interest) and allows trade mainly because in interest there is no risks, no liability and the creditor does not put works and efforts to earn the return. While, trade is allowed because trader takes risks, liability and put his efforts in producing the goods in order to earn the profits. Philosophy of Islamic Finance and Banking ❖The forms of businesses that are allowed by Shariah include trade (al-bay’), profit and loss sharing (Musharakah and Mudarabah), Leasing contract (al-Ijarah) and agency contract (Wakalah), etc. Characteristics of shari’ah ▪ Shariah as a divine code of laws formed the basis of Islamic finance, with the following characteristics: 1. Originality of Shari’ah as divine laws. ▪ All Shariah rules are free from mistake and injustice. 2. Comprehensive ▪ Shariah is a code of life, which encompasses all aspects of human life, be it economic, political, social and cultural matters. 3. Universal and permanent Shari’ah was revealed to everybody regardless of their races, places and centuries. Rules in Quran mostly contain general principles only, they are flexible and adaptable in all situations, times and places. Shari’ah is guaranteed by Allah SWT for its permanence and originality until the day of Judgment. 4. Balanced and moderate Shariah balances between the body and the soul, between the intellect and the emotions, between this life and the eternal one. It balances between theory and reality, between thinking and acting, between the unseen and the apparent. 5. Realistic and Practical Shariah is capable of addressing all human needs and conditions. Its rules are realistic and can be practiced by all human being. Forbidden Practices in Islamic Banking & Finance There are various practices which have been declared forbidden by the Qur’an and the Sunnah. These include: i. Prohibition of Riba (Interest) ii. Prohibition of Gharar (Uncertainty) iii. Prohibition of Maysir (Gambling & speculation) iv. Prohibition of hoarding v. Prohibition of debasement of money 8 1. Prohibition of Riba Riba literally means an excess, expansion, increase, addition and growth Technically, Riba is defined as unlawful gain derived from unequal quantity of the counter values in any transaction or unjustified excess above and beyond the capital. Two types of Riba: – Riba al-nasi’ah is a loan contract where borrowers are contractually and legally bound to pay excess or above the principal amount. – Riba al-fadl occurs when a commodity is exchanged for the same commodity from the ribawi commodities in an unequal amount and/or a delay of the delivery of one of the commodities – These ribawi commodities include: gold, silver,, wheat, barley, dates and salt. – If exchange involves gold for gold or money for money or wheat for wheat, the rule of equality and spot delivery must be applied otherwise it is riba. 9 2. Prohibition of Gharar Gharar literally means risk, uncertainty and hazard Technically, Gharar can be define as: – A contract which contains excessive risk to either parties which could lead to loss of properties – A sale in which the vendor is not in the position to hand over the subject matter to the buyer whether the subject matter is in existence or not. Types of Gharar ✓ Gharar due to non-existence of the exchanged counter values (settlement risk or counterparty risk). ✓ Gharar due to inadequacy or inaccuracy of information ( non disclosure of material information on exchanged subject matter ✓ Gharar due to undue complexity of the contract ( e.g. derivatives contracts). 10 3. Prohibition of Maysir Maysir is a game of pure chance where one party might gain at the expense of others. In Surah Al-Ma’idah: 90 – 91, Allah clearly condemned and prohibits gambling. The reason: Allah said it creates enmity in society & distracts believers from worshiping Allah. In contemporary society – most countries consider gambling illegal because: ✓ it does not contribute to wealth creation. ✓ It creative an addictive behaviors that destroy society. It divert scarce resources from real sector of economic activities to games of chance and speculation 11 4. Prohibition of Hoarding Islam discourages hoarding of money which is destructive to society and also harms individuals. The invention of money meant to facilitate trade, i.e. exchange of goods and services. Hoarding deprive the money of its natural function as a medium of exchange and reduce amount of money in circulation. Shortage of money in the economy negatively affects trade and investment. This will increase unemployment and poverty. 5. Prohibition of debasement of money During the prophet’s time, debasement of currency in all forms was strictly forbidden. Trading in money encourages counterfeiting and so confidence in the currency can be lost, resulting in inflation. Sale and purchase of money as merchandise is a major cause of monetary instability in our contemporary world. Even western economist are of the view that it should not be allowed. 12 FIN 3103 Week 9 Theory of Right In Islamic Law The Philosophy of Rights in Islam Concept of rights in Islam basically emphasis meeting & respecting our obligations to Allah, our family, parents, neighbours & society at large. Our obligations to Allah is to believe in Oneness of Allah, follow His command and to distant ourselves from Shaitan and the false deities. Human rights free human being from his desires and fantasy so that he/she can meet his responsibilities to his family, neighbour & society at large Human rights affirm that Allah is the One who bestows upon us blessing and provisions, and the fact that nothing will ever happen to us except what Allah has decreed for us. Definition of Rights (al-Haq) in Islam Right (Haqq) literally means “ real facts” or “ truth or anything related to facts. Conventionally the expression Al-Haq or Right signifies material and moral possessions, such as the right of ownership, the right of utility, the right of faith and the right of dignity. Musa ( 1954) defines rights as benefits ( maslahah) which the Allah has granted to the individual or community or both. Dr Wahbah al-Zuhaili defines haqq as what the law recognises for an individual to enable him to exercise a certain authority or bind others to perform something in relation to him. Cont… ّ ‫الحق من ربّكم فمن اِهتدى ف ِانما يهتدي‬ ‫قل ياأيّها النّاس قد جاءكم‬ ‫لنفسه ومن ض ّل فاِنما يض ّل عليها وما أنا عليكم بوكيل‬ This means: "Say:" O mankind, indeed has come to you the truth (Al-Quran) from your Lord so whoever is guided, then surely the clue for his own good. And those who go astray, surely the error harm himself. And I am not a guardian of your souls. (Q.S. Yunus: 108). The Characteristics of Human Rights in Islam 1. Divinity these rights are revealed by Allah. This characteristic implies two facts: ✓ Human rights are sacred and sanctified. Thus, they are preserved from all kinds of aggression. ✓ They can not be abrogated, concealed or suspended. 2. Comprehensiveness The rights in Islam include all human rights: Religion, Social, economic and political. They are preserved and secured. Example, right to owned property, get married, socialise with friends. 3. Generality Rights are general & include both animal and human rights. 4. Balance between the individual and the group Human rights in Islam are inclusive; they comprehend all the rights that insure balance between the individuals and the groups. So neither the individual rights are neglected nor those of the group's are lost and missed. 5. Rights are not absolute They are rather restricted at many levels to avoid tyranny and deviation Types of Rights 1. The rights of Allah ▪ The most important right Allah has on mankind is that man should have faith in Him alone. ▪ Man should acknowledge His authority and associate non with Him. ▪ Allah’s rights are above all human rights. For example, performing salat & fasting, a person must sacrifice many of his personal rights. ▪ A man must fulfil his obligation to Allah such as pray five times a day, fast on month of Ramadan, pay Zakat from his wealth & performed Hajji ▪ These requires man to sacrifice both his physical and financial resource in order to meet these obligations. ▪ Islam requires man to sacrifice minimum of his life, property & rights when performing the rights of Allah. Types of Rights 2. Right to Life ▪ The first and the foremost basic human right is the right to live and respect human life. ▪ According to Islam, any transgression on the life of a single individual is regarded as a transgression on mankind as a whole. ▪ The Quran says: Whosoever kills a human being without (any reason like), unless it be for man slaughter or for mischief in the land, it is as though he had killed all mankind... (5:32) ▪ Prophet ( P.B.U.H) said: the greatest sins are to associate something thing with Allah and to kill human beings. Types of Rights 3. Rights to Justice ▪ Right to justice is one of the main objectives of Shariah aimed at realizing the dignity of man and fulfilling the interest of the people. ▪ The Holy Quran has laid down: "Do not let your hatred of a people incite you to aggression" (5:2). "And do not let ill-will towards any folk incite you so that you swerve from dealing justly. Be just; that is nearest to heedfulness" (5:8) ▪ Justice eradicate people from oppressions & injustices. Types of Rights 4. Rights to freedom ▪ Islam grant freedom of movement, no one should be hold as a slave. Allah creates human to be free. ▪ Islam prohibits slavery to ensure man’s freedom of movement. ▪ Prophet, peace be upon him says: “Whoever frees a slave, Allah will free (against every organ of the freed person) every limb of the liberator from hell-fire” Types of Rights 5. Right to basic Needs ▪ Islam everyone has rights to basic necessities such as food, shelter, healthcare, & education. ▪ Quran says: “And in their wealth there is acknowledged right for the needy and destitute”. (51:19). ▪ Anyone who asks for help and anyone who is suffering from deprivation has a right in the property and wealth of the Muslims; irrespective of the nations, race or religion. Types of Rights 6. Freedom of Equality ▪ Islam recognises the absolute equality of men irrespective of race, colour, gender & nationality. ▪ Quran said: "And we set you up as nations and tribes so that you may be able to recognize each other“. Indeed, the noblest among you before God are the most heedful of you" (49:13) ▪ The superiority of one man over another is only on the basis of God-consciousness, purity of character and high morals. Types of Rights 7. Property Rights ▪ Property rights include right to earn and acquire property, right to own, possess and enjoy property, and finally the right to alienate it through sale, gift, exchange, will or through other lawful means. ▪ Islam recognized all these rights to property and granted the same to its followers some fourteen hundred years ago ▪ however, in Islam all resources in this universe belong to Allah. Allah appoints man as his Quran Al-Dhaariat, Verse 19: “And from their properties was [given] the right [Haqq] of the [needy] and the deprived. ▪ Al-Baqarah, Verse 188: “And do not consume your property unjustly …while you know [it is unjust]. SOURCES OF AL-HAQ Al-Quran As-Sunnah - Primary source - Secondary source - Right is the element of the dignity of - All about the Prophet said, did, or man granted to him by God approved which can be used as evidence - Allah knows well what suits His for a legal rule. Muslims had consensus creation at all times, what benefits among them that the Sunnah has the or harms man, what makes him legal status of wajib (compulsory). happy, sad, successful or miserable. - In this respect Allah said: “Obey Allah - Our firm belief in the truth and and the Messenger”(Surah justice of Islamic rights and principles Muhammad,3:32) is due to the fact that Allah, the Most - Also explain what was revealed in the Merciful and only Creator of man, Quran. reveals them. He also legislated what - All aspects of human rights in the suits best and fulfils the essential Sunnah complement and clarify the needs of all His creatures on earth and conceptual framework of human rights in makes their lives successful, secure the Quran. and joyful. CONCLUSION Islam has laid down some universal fundamental rights for humanity as a whole, which are to be observed and respected under all circumstances whether such a person is resident within the territory of the Islamic state or outside it, whether he is at peace with the state or at war. Right is a favour granted by the Creator as it is one of His names Right is not absolute but restricted by respecting the right of the others & avoid doing harm to the public. Rights also involves meeting one’s obligation to Allah, fellow human being & animals as well. FIN 3103 Week 10 Asset (Al-amwal) And Ownership CHAPTER OUTLINE Definition of asset (al-amwal), its types Definition of al-milk and milkiyyah, types and causes of ownership Introduction Ownership is usually seen in property or asset. There is strong relationship between human being & property. Ownership of properties is the main features that differentiate capitalism & socialism. In capitalism all resources land, labour, capital & businesses are privately owned while in socialism nearly all the resources are owned by state. Islam economic system strikes balance between privately owned resources (houses, land, & firms, etc) & publicly owned resources (such as mineral resources, forest, water, etc). ASSETS (AL-AMWAL) Definition of Mal ( asset or wealth or property) Mal in Arabic signifies whatever a man may acquire and possess; in form of physical asset ('ayn) such as gold, silver, cars, house, animals, land or usufruct (manfa'ah) such as residing in house, riding a rental car, leasing land, etc. On the other hand, whatever a man cannot possess cannot linguistically be regarded as mal. For instance, birds in the sky, fish in the water, trees in the forest, and mines deposit. According to the Maliki jurist, Al-Shatibi mal as the thing on which ownership is conferred and the owner when he assumes it excludes others from interference. Characteristics of Asset ✓It must have commercial value; ✓ It must be owned and useful such as house, cars; ✓It must be capable of being stored; ✓ It must be beneficial in the eyes of the Shari'ah; ✓ The ownership of the thing must be assignable and transferable. Classification of Tangible Property 1. Movable & Immovable properties ▪ Movable property (Mal Manqul) – is a property that can be moved from one place to another place without changing its original form & structure, e.g. cars, gold, silver, computer, cloths, ▪ Immovable property (Aqar) - is a property that cannot be moved from one place to another place, for e.g. land, building & plantations. 2. Valuable property (Mutaqawwim) & invaluable (Ghair Mutaqawwim) Valuable property (Mal Mutaqawwim) – is an asset that can be physically possessed and its benefit is permissible by the Shariah to be enjoyed, such as land, houses, cars, gold, machines or halal food, etc. Invaluable property (Mal Ghair Mutaqawwim) - are things that may not be possessed by a person such as river, fish in the sea, mineral resources, birds in the sky or shariah does not permit person to acquire & benefit from them such pig, wine, etc. Note: under Islamic laws, contract is only valid in valuable property not invaluable property. Valuable property can be compensated in the case of damages. Classification of Tangible Property 3. Homogeneous ( Mithly) & Heterogeneous ( Qimi) Homogeneous (Mithly) - are properties that are similar and cannot be differentiated in terms of size, brand, colour or other features & may or may not have same market value( price). E.g. a grain of rice; financial asset such as shares, etc. Heterogeneous (Qimi)- are properties that can be differentiated in terms of size, brand, colour & quality. These differences to lead to differences in prices. Example: Proton & Toyota cars; gold & silver. Implications: in case of any damages of mithly asset, compensation must be the same. However, in case of Qimi asset, compensation price differ. 4. Perishable & Non-Perishable Assets Perishable (Istihlaki) – are assets or goods that can easily be perishable by consumption, like any kind of food. Non-perishable (Isti’maly) – are goods or assets which cannot be destroyed with repeated use, like cloths, book, pen, car or a house. Implications: contracts related to both assets may not be the same under Islamic laws of contracts. DEFINITION OF OWNERSHIP (AL- MILKIYYAH) Literally: Ownership is a state of possessing a thing and ability to dominate and dispose it. Technically, Ownership define as an Islamic legal relationship between a human being and property, which renders the property specifically attached to him, and which gives the owner the right to deal in that property unless there is a legal impediment to a specific dealing ( Zuhaily) Properties that cannot be privately owned in Islam include: 1. Public Goods, such as public roads, bridges, water, Parks, etc. 2. Waqf Properties 3. Baitul Mal Properties Types of Ownerhsip Complete Partial Legal ownership ownership Legal and ownership without beneficial ownership; or vice beneficial versa. An owner ownership. This holding only one or the means that the other is unable to enjoy the full rights or owner enjoys the benefits that come legal rights with total ownership. associated with There are 3 types of legal ownership partial ownership: (e.g. title) and the *Legal ownership or benefits derivable ownership of the property alone. from usufruct (e.g. habitation within a *Personal usufruct ownership. Example: real estate). rental property, Example, you buy machines house for your *Easement rights own use. (haqqal-’irtifaq). Example, road passes in your land. Partial Ownership There are three types of Partial ownership: 1. Ownership of the property alone property may be owned by one person & its usufruct may be owned by another person. Example: a person may write a will, giving another person right to live in his house or land for certain period of time or for the rest of his life. When that period completed, the heirs will assume complete ownership. 2. Personal usufruct ownership Ownership of usufruct can be acquired through loan, lease, Waqf or permission. For instance: ✓ A person lend another person his property such as land, house or car or machines without fee & can take it anytime he/she wants. ✓ A person may lease property such as land, house or machines such as cars & pay rental. He/she is entitle to right of usage until the contract expired. ✓ A person may give his property as Waqf & its usufruct is given to a name of group of individuals as beneficiaries. 3. Easement rights ✓ Rights of others to use water ( well or spring water) in privately owned land either for drinking or irrigation. ✓ Rights of passage if the public road passes through a privately owned land or property. ✓ Rights of neighbors , for e.g. in upstairs to pass through downstairs; share streets & facilities. 2. Contracts This refers to the transferring of ownerships through contracts This is the most important and commonly used means of establishing ownership (e.g. sales, gifts, exchange, wills, etc). Ownership transfer through contracts can either be through mutually trade & commerce such as buying & selling property, cars, giving property as gifts or exchange with other property; Or Ownership can be directly transferred through obligatory contracts. There are two types of obligatory contracts which result directly in ownership: 1. Obligatory contracts performed by legal authorities on behalf of the owner (e.g. selling property of debtor to repay debts, confiscating illegal property). 2. Obligatory nullification of ownership through: ✓ Pre-emption rights – a partner may gain ownership of sold property from buyer when one of the partner sold the property without a consent of another partner in a joint ownership property; but buyer must be compensated. ✓ Public appropriations. State may possessed privately owned property for public benefits such as acquire private land for constructing roads or extending Mosque. But state must compensate the owner of the property. 3. Succession There are two ways for succession ownership to occur: Inheritance (al- ‟irth) succession of properties owned by the same individual when transgressor compensate (tadmin) them for destruction, usurped, or damaged property 3. Derivation from Owned Property ✓Extending the existing building to include many rooms, & other buildings ✓Plant new trees or existing trees producing more fruits. ✓Buy more animals in the farm or existing animals such as sheep, cows producing more offspring's & producing more milks. FIN 3103 Week 11 Money and Profit In Islam OVERVIEW : ✓ INTRODUCTION OF MONEY ✓ MONEY IN ISLAM ✓ ISLAMIC DINAR ✓ THEORY OF PROFIT IN ISLAM ✓ CONCLUSION INTRODUCTION ❑ WHAT IS MONEY ? Money is anything that is generally accepted as a medium of exchange. Something that can be accepted by people in exchange for goods and services for payment and debts. Money has evolved over time from barter system to items such as cowry shell, stones, leather, to gold & silver, to paper currencies & electronic money Three different types of money: Good whose value serves as the value of COMMODITY money. Eg : Rice, tobacco, gold & silver coins. MONEY In most countries, commodity money has been replaced with fiat money Money that derives its value from government regulation or law. FIAT MONEY as the main currency of the country. any money declared by a government to be legal tender. consists of the book credit that banks extend to their depositors. BANK MONEY Transactions made using checks drawn on deposits held at banks involve the use of bank money. Functions of Money Generally, money serves as medium of exchange, unit of account, store of value & standard of deferred payment. 1. Medium of Exchange – Basic purpose of being a medium of exchange and a measure of value. – Society used money to buy & sell goods and services. – if need to be exchanged or borrowed – payments of both sides must be equal, so that it is not used for the purpose it is not meant for 2. Unit of Account – Islam viewed money as thaman (a unit of account to serve as the price of anything) – Money is used to price goods & services for exchange/payment 5 Functions of Money 3. Store of value – Society can store their wealth in the form of money, for e.g. saving money in bank. – People can also transform their wealth from physical assets such as properties into money and can also transform them back from money into real assets such as buying properties. – However, as inflation increase over time, money cannot be a good storage of wealth. 4. Standard of deferred Payment – Money prices goods and services that people buy now but pay later. – Money make it possible to buy goods and services on deferred payment or credit. 6 Money in Islamic Perspective o Islamic point of view : - Money is the means of fulfillment of human needs and desires. - It is needed by every society as it is a means of exchanging goods & services o Islamic Economics : - Money is definitely distinguished from commodities because commodity has intrinsic utility and can be utilized directly without exchanging it for some other thing but money has no intrinsic utility that can satisfy human needs directly. Rules Regarding Islamic Finance 1. Any predetermined payment over and above the actual amount of principal is prohibited. 2. The lender must share in the profits or losses arising out of the enterprise for which the money was lent. Rules Regarding Islamic Finance 3. Making more money from money is not acceptable (in lending). 4. Gharar (Uncertainty, unnecessary Risk or Speculation)& gambling are prohibited. 5. Investments should not involve practices or products that are forbidden or even discouraged by Islam. Dinar & Dirham were used as a medium of exchange by Muslims through out the Islamic history until the fall of the Uthman caliphate. Dinar refers to gold coins & Dirham refers to silver coins, both were commonly circulated. However, Dinar is perhaps the most stable form of currency the world has ever known. The History of the Dinar & Dirham ❑ The Muslims used gold and silver by weight. ❑ The dinar and dirhams they used were made by the Persians. ❑ the first coins that can be assigned to the Muslims are copies of silver dirhams of the Sassanian Yezdigird III, struck during the Khalifate of Uthman (R.A). Since then…… Gold and silver coins remained official currency of Muslim states until the fall of the Khalifate. Since the fall of the caliphate, dozens of different paper currencies were made in each of the new postcolonial national states where one Muslim nation (Dar al-Islam) were disintegrated into many states such as Saudi Arabia, Iraq, Jordan, Syria, Egypt, etc. Paper money Since then, paper money has evolved through three major stages, these are: 1] A promissory note backed by gold ( Gold standard). 2] A process of unilateral devaluation leading to a complete revocation of the contractual agreement( Bretton Wood system). 3] A fiat money - piece of paper & coin not backed by any commodity, whose legal value is determined by the compulsion of the State Law, i.e. it is a legal tender. The Shari‘ah money…… Are the Gold Dinar and the Silver Dirham. Or any commodity commonly accepted as a medium of exchange. Imam Malik said money is “any merchandise or commodity commonly accepted as a medium of exchange.” These are…….. The Islamic Dinar & Dirham According to Islamic laws…. The Islamic Dinar is a specific weight of 22k means 22karrat gold (91.7% pure gold) equivalent to 4.25 grams. The Islamic Dirham is a specific weight of pure silver equivalent to 3.0 grams. Umar Ibn al-Khattab established the known standard relationship between them based on their weights: "7 dinars must be equivalent to 10 dirhams." Differences Between Islamic Dinar & Fiat Money ISLAMIC DINAR FIAT MONEY Gold coins used as a medium of Fiat money is used as medium of exchange by Muslims through out exchange since government declared the Islamic history until the fall of it as a legal tender the Uthman caliphate. state-issued money which is neither The most stable form of currency convertible by law to any other the world has ever known. thing, nor fixed in value in terms of any objective standard. consist of minted gold coins, Paper & coin printed without Dinar, and silver coins, Dirham & intrinsic value. It derives its value have intrinsic value. from government regulation or law. Advantages of Islamic Dinar 1)Stable Money ✓Since dinar is gold itself, the creation and destruction of money as in the present system is impossible. ✓The value of currency in terms of its purchasing power could be expected to be stable over time. ✓Hence the dinar could play its role as a store of value much better than the fiat money in an interest based economy. ✓ With gold, inflation is zero, so price cannot change. 2. Excellent Medium of Exchange ✓ Gold is priced and revered globally, ✓ It is something that is always valued by people of all nations and creed. ✓ Thus, dinar could easily play the role of a preferred global currency 3. Minimizes Speculation & Manipulation ✓ Today, speculation & manipulation in foreign exchange markets are common due to the existence of different currencies and the cross exchange between them. ✓ However, adopting dinar as a single global currency, it will eliminate this speculation & manipulation. 4. Reduce exchange risks and Promote Trade ✓ When countries use a single currency like Euro then it reduces exchange rate risks due to volatility. This will promote international trade as currency will be stable.. ✓ However the dinar is even better than Euro because gold is something that has intrinsic value and treasured by all nations. ✓ It thus acts as a unified global currency unlike Euro which is unified regional currency. Theory of Profit in Islam Islam encourages Muslims to work harder & gain wealth through profits especially in trade & commerce. However, profits gain should be moderate. The theory of Profit in Islam is built on the principle of ‘iwad’ which says profit is created from the trade contain 3 elements, i.e. risk (ghorm), work & effort (kasb) & liability/responsibility (daman) Therefore, firms should be concerned with the needs of customers and not just focus on profit maximisation Principle of ‘iwad’ ( counter value) 1. Risk (ghorm) – the risk of ownership which implicate itself with risks arising from volatile market price movement. Means inability to sell goods at a price higher than the average cost which leads to loss. 2. Work & effort (kasb) – the changes of inputs into output includes the element of work or effort as it adds value to the process of production. 3. Liability/responsibility (daman) – the contract of sale must prepare a warranty agreement that favours the customer when the goods sold are proven defective. Profit Margin Contain 3 element of iwad = lawful FIN 3103 Week 12 Business Contracts In Islam CHAPTER OUTLINE Introduction Contracts in Islam Right and Validity of business contracts in Islam Termination and Discharge of contract Options (Khiyar) INTRODUCTION ▪ Contract in Islamic law is a complex legal discipline in both jurisprudential foundation and its practical functions. ▪ It covers a variety of dealings and transactions to meet the needs of the society. ▪ The whole idea of having a contract is to satisfy the consent of both parties to a contract and not only in Islamic legal system but also in other legal system. ▪ contract is the best available means to reflect the intention & consent of both parties. ESSENTIAL ELEMENTS IN BUSINESS CONTRACT ✓For a valid contract to take place in Islamic law, the contract must have the following conditions: 1.Contracting Parties (Buyer & Seller) 2.Offer & Acceptance 3.Subject Matter 4.Price/Consideration 1) CONTRACTING PARTIES (BUYER & SELLER) Buyer & seller must be legally competent to enter into a contract. The competence to transact in Islamic law is measured largely by two aspects, namely puberty (baligh) and prudence (rushd) as revealed in the Quran “And try orphans until they reach the age of marriage, if the you find sound judgment in them, release their property to them…” (an-Nisa 6) The capability of the parties to contracts is one of the most important condition for a valid contract. In Islamic law, no person can validly conclude a legal transaction if he/she has not attain legal age (bulugh) and sound mind ( rushd). 2) OFFER AND ACCEPTANCE (IJAB & QABUL) With reference to an expression of both offer and acceptance, Islamic law of contract recognizes both offer & acceptance can either be: ✓ Orally ✓ In writing ✓ Conduct such as by body language ✓ Silence However, under Islamic law both the offer and acceptance are to be jointly connected in one single session without any gap in time or place. It is agreeable to all schools of law that certain interruptions during the session such "as stopping to pray, or discussing other-subjects, changing positions or attitudes, or even falling asleep are held to terminate the majlis and therefore the offer & acceptance should also be immediate. Islamic law allows right to revoke the concluded offer and acceptance ( khiyar al- majlis) provided both the parties are still available at the session of the contract. 3) SUBJECT MATTER ✓ Lawfulness. The object must be lawful, valuable and can be legally owned. ✓ Existence. The object of a contract must be in existence at the time of contract. ✓ Deliverability. The object must be on something that can be delivered. Thus, Islamic law prohibit the sale of a camel which has fled or a bird in the air or a fish in water. ✓ Precise determination. The object of a contract must be measurable in terms of its essence, size, quantity, quality and value. 4)PRICE/CONSIDERATION ✓ As for the price, Islamic law does not restrict it to a monetary price, but it may be in the form of another commodity. ✓ However, the price must be in existence and determined at the time of the contract. ✓ It cannot be fixed at a later date with reference to the market price, nor can it be left to be determined by a third party. ✓ In contract of money-exchange (sarf), the rule of riba must be adhered to render the contract valid, i.e. spot not future sales. TYPES OF SALE Basically there are three types of sale, bay sahih, bay Fasid & bay Baatil 1. Valid sale ( bay sahih) ❑ A sale is valid if all the elements & conditions are present & lawful. 2. Voidable sale due to defect ( bay fasid) ❑ A sale is valid as all conditions for a valid contract are present, but there are some forbidden elements on it. These incudes: -Monopoly on necessary goods -An-najash : cheating by selling at higher price -Sales during solat jumaat time -Selling lawful goods knowingly to produce unlawful product, for example selling grape to produce liquor 1. Null & Void ( bay baatil) ❑ A sale is not valid as some conditions are not present or it has elements that are prohibited such as: sales based on interest sales based on gambling sales of forbidden products i.e liquor, pork etc sales containing elements of uncertainty 9 WHAT IS FORBIDDEN IN BUSINESS 1. Sales of prohibited goods/Items ▪ Islam has not permitted producing, selling and purchasing of goods, which are prohibited in Islamic law such as drugs, wine, pork, etc ▪ The Prophet (p.b.u.h) said: "When God prohibits a thing He prohibits (giving and receiving) the price of it as well.“ 2. Gharar ( uncertainty) ▪ Islam has also prohibited any kind of transaction involving gharar (uncertainty) as this could lead to quarrel or litigation. ▪ However; if the element of uncertainty is very small, the transactions are permissible. ▪ Islam encourages fairness, justice and transparent in any transaction. ▪ Gharar is originated out of deception through ignorance by one or more parties to a contract. In order to avoid gharar, the contracting parties must : ✓ Ascertain that both the subject matter and prices of the sale exist, and are able to be delivered ; ✓ Specify the characteristics and amounts of the counter values, e.g. 1 kg Grade A of rice = RM 10. ✓ Specify the quantity, quality and date of future delivery, if any. The following are some examples of gharar: ▪ Selling goods that the seller is unable to deliver; ▪ Selling known or unknown goods against an unknown price, such as selling the contents of a sealed box; 3. Hoarding ▪ Islam condemns hoarding to create shortage in order to make high profit at the cost of public interest. ▪ Islam, however; allows normal trade where buying and selling of goods leads to a reasonable profit. 4. Fraud ▪ Islam prohibits fraud in business dealings. ▪ Prophet (p.b.u.h) said: "Sell the good and bad separately. He who deceives is not one of us" The sin of fraud is greater if the seller supports it by swearing falsely. The Prophet has said, "Swearing produces ready sale but blots out blessing”. 5. Trade of legal goods for illegal use ▪ Islam prohibits buying or selling what’s legal if we know that it will be used for illegal use: weapons, abortion drugs, and so on. 6. Interest (Riba) ▪ Riba is a prominent source of unjustified advantage, because Shariah does not consider money as a commodity such that there should be a price for its use. ▪ Money is a medium of exchange in an asset oriented economy, and a store of value. ▪ The prohibition riba is mainly due concern for social justice. Riba is said to reinforce a tendency for wealth to accumulate in a few hands ▪ Muslims are not allowed to pay or receive riba. This is a shared value in all religions. The Quran is explicit about it and says, “Allah- has permitted for you trade and prohibited interest" (2 : 275). ▪ Riba include both riba-an-nasiah and riba-al-fadl are prohibited ▪ Riba-an-nasiah occurs as the lender give moretime to the borrower to repay the loan in return for addition (financial increment). ▪ Riba-al-fadi arises if gold, silver, wheat, barley, dates and salt are exchanged against themselves with unequal proportion Termination & Discharge of Contract Termination relates to the circumstances in which the contract is brought to an end. Discharge is where each party is freed from their continuing obligations under the contract. The Shari'a attempts to eliminate all sorts of risk or uncertainty (gharar) in contractual transactions, from the beginning to the end of the contract. A CONTRACT MAY BE DISCHARGED IN ONE OF THE FOLLOWING WAYS 1. By performance Termination 2. By and 4. By breach discharge of express contract agreements 3. By operation of the doctrine of frustration 1. BY PERFORMANCE (ADA’) Contract can come to an end when the goals or the purposes of the contract have been achieved & there are win-win situation for both parties. Thus, each party is discharged from its obligation. Discharge of a contract takes place when parties perform their duties or obligations as required by the contract. Performance thus signifies the end of the contract. 2. BY EXPRESS AGREEMENT Both parties to a contract may agree to terminate the contract under certain conditions outlined in the contract. Parties may agree to discharge the contract as soon as some obligations are met or under circumstances that are not favourable to either party. For example, both parties agreed to terminate the contract when one partner is dishonest, cheat or involved in fraudulent activities. 3. BY OPERATION OF THE DOCTRINE OF FRUSTRATION A contract may be discharged by frustration due to unforeseen circumstances. A contract may be frustrated when there is a change in circumstances, after the contract was made, which is not the fault of either parties, & the situation renders the contract either impossible to perform or deprives the contract of its commercial purpose. Example: bank agreed to finance the project but later reject after the project started. If such situation existed, each party is discharged from future obligations under the contract and neither party may sue for breach. 4. BY BREACH (NAQD AL-’AQD) Breach of contract occurs when one party to the contract fails to discharge his obligations under the contract or does something that contradicts the contract. Breach of contract may also occur if one party makes it impossible for the other to discharge his obligation and duties as per the contract. Parties may terminate a contract if a court finds that there is a breach of contract & it caused damages and loss to the affected party. Example, customers take house loan but defaulted his or her payment. Al-KHIYAR(OPTIONS) Al-khiyar is an option given to both the seller & the buyer whether to hold their sale or discontinue the sale according to certain conditions or reasons Types of Al-khiyar include: ✓ Khiyarul Majlis ✓ Khiyarul Sharat ✓ Khiyarul Ru’yah ✓ Khiyarul Naqd ✓ Khiyarul Wasf TYPES OF KHIYAR 1. Khiyarul Majlis. ▪ Shariah has given each party in “Aqad” an option to accept or reject the contract before the session of the contract ends. In other words before the contract is concluded & signed. 2. Khiyarul Sharat. ▪ Shariah has allowed each party to set conditions that should be agreed by both and included in the contract. ▪ A party can exercise his option if the conditions are not meet. ▪ Example, buyer can state in the agreement that if developer cannot build the house within specified period of time, he may or may not buy the house. ▪ Or if the supplier cannot deliver the goods on agreed time, he may or may not buy the goods. TYPES OF KHIYAR 3. Khiyarul Ru’ya. ▪ Shariah has given the buyer the choice to buy or not to buy the goods he/she did not see or cannot be delivered on time. 4. Khiyarul Naqd. ▪ This is the option that states that if the buyer will not pay the full price within specified period of time, for e.g. within 3 days, the agreement will be forfeit. 5. Khiyarul Wasf. ▪ This is an option which gives the buyer the right to buy or not to buy a particular goods if failed to meet certain specifications & attributes. ▪ Example, if the manufacturer or developer did not make the product based on the contract specifications, buyer has an option to buy or not to buy it. FIN 3103 Week 13 Classifications of Business Contract In Islam CHAPTER OUTLINE ▪ Introduction ▪ Classification of contracts in Islam Partnership contracts Sales contracts Leasing contracts Debt contracts Other contracts ▪ Unlawful Contracts in Islam INTRODUCTION Most of the Islamic banking and finance contracts are based on cash-sales, deferred sales, partnership-based contracts leased-based contracts, security-based contracts & other contracts. Therefore, Shari’ah contracts in trade and commerce are divided into four categories, i.e. Partnership contracts, Deferred sales, Cash-sales & other contracts Classifications of Contracts in Islam Contracts Classification Profit Sharing Other Contract Deferred Sale Cash Sales Contracts -Musyarakah -Murabahah -Ar-rahn -Mudharabah - Bai Bitaman - Bay al-Sarf -Kafalah -Muzara’ah Ajil -Bay al-salam -Wakalah -Musaqah -Bay al-Istisna -Bay al-dayn -Wadiah -Bay ai-Istijrar -Hiwalah - ijarah -Ibra’ Bay ai-inah THE RELATIONSHIP BETWEEN ISLAMIC FINANCIAL SYSTEM WITH ISLAM AND SYARIAH ISLAM AKIDAH SYARIAH AKHLAK IBADAH MUAMAL

FIN 3103 Corporate Governance Weeks 2 & 3 PDF

Document Details

Tags

Related

Summary

Full Transcript

Upgrade to continue