SS 56 · Guarantees, documentary credit and Rahn

SS 56: Liability of Investment Manager

What this standard is about

An investment manager is anyone who manages a client's investment money with the client's permission. This takes three common forms: a mudarib (the manager in a mudaraba partnership, where one side provides capital and the other manages it), an investment agent (wakil) appointed to invest on the client's behalf, and a managing partner in a musharaka (joint venture).

The standard answers one central question: if the investment loses money, who bears the loss? It defines misconduct (ta'addy) and negligence (taqsyr), lists the manager's duties, and sets out what happens when the manager is at fault. It also covers commitments by third parties to bear losses and the liability of service agents in sukuk and syndicated financing deals.

Why it exists

The default rule in Islamic law, agreed by scholars across schools, is that a manager holding someone else's capital is a trustee, not a guarantor. If investments were guaranteed against all loss, the deal would become a disguised interest-bearing loan, with profit guaranteed and risk removed. But managers must still be held to account when they misbehave or neglect their duties. This standard draws that line precisely and gives institutions a basis for action against a manager who breaches trust.

The key rules, simply put

An investment manager is a trustee of the capital. He is not liable for investment losses that happen in the normal course of business.
He becomes liable when the loss comes from his misconduct (ta'addy), his negligence (taqsyr), or his breach of the agreed terms.
Misconduct means doing what he was not allowed to do. Negligence means failing to do what a careful manager should have done.
The manager must act in the interest of the capital provider and manage with the care expected in normal business practice.
A manager may not guarantee the capital or promise a fixed return in advance, because that would remove risk-sharing and resemble interest (riba).
A third party, independent of the investment contract, may voluntarily commit to cover losses, as long as the commitment is not tied to the investment contract itself.
If misconduct or negligence is established, the institution may take action against the manager, and the manager bears the resulting loss.
The standard also addresses the liability of service agents in sukuk structures and syndicated financing, where an agent handles assets or payments for investors.

An everyday example

A client gives an investment manager $1 million under a mudaraba agreement to invest in halal stocks. The market falls and the portfolio drops to $900,000 through no fault of the manager. Under this standard, the client bears the loss. But if the manager had ignored the agreed investment limits and put the money into forbidden speculative derivatives, the resulting loss would be the manager's responsibility.

Words to know

Mudarib — the manager in a mudaraba partnership; provides work, not capital.
Mudaraba — a partnership where one side provides capital and the other provides management; profit shared, loss borne by capital.
Wakil — an agent appointed to act on someone's behalf.
Ta'addy — misconduct; exceeding what one was authorized to do.
Taqsyr — negligence; falling short of the care required.
Riba — interest; any guaranteed extra charged on a loan. Forbidden in Islam.

Source

AAOIFI Shariah Standard No. 56 — https://islamicmarkets.com/index.php/publications/aaoifi-shari-ah-board-adopts-new-shari-ah-standards-on-gold-and