Wahed Invest was fined $300,000 by the US’ SEC for misleading customers in early February. As a poster-boy of the Islamic finance sector, how can the robo-advisory regain consumer trust?

London: Earlier this month, the Securities and Exchange Commission (SEC) charged New York-based Islamic investment platform Wahed Invest for making misleading statements and breaching its fiduciary duty, and for compliance failures related to its Sharia advisory business.

In summary, the SEC said Wahed advertised proprietary funds which did not exist; ensured investors that Wahed would periodically rebalance customers’ advisory accounts but did not rebalance customers’ advisory accounts; launched a proprietary Exchange Traded Fund (ETF) with customers’ advisory assets without customers’ consent for their assets to be used to fund the ETF; and did not adopt and implement written policies and procedures addressing how it would assure Sharia compliance on an ongoing basis.

Wahed Invest agreed to a cease-and-desist order, to pay a $300,000 penalty, and to retain an independent compliance consultant among other undertakings.

One former Wahed customer expressed her dismay about Wahed. “This leaves such a horrible taste in the mouth,” she said. “I withdrew all my funds from Wahed Invest.”

As well as reaching out to Wahed Invest for a response to the SEC’s findings, Salaam Gateway spoke to several Islamic finance practitioners to understand what lessons can be learnt not only for Wahed but also for other Islamic start-ups, their customers and investors.

One Islamic finance practitioner, who asked not be named, said Wahed needs to make specific changes to regain their customers’ trust.

“The assertions by the SEC led me to believe that in order for anyone to put money with Wahed again, they need to undertake a cultural transformation along with a governance reform,” he said. “One that sees the implementation and disclosure of governance practices, the establishment of independent board seats, and a number of independent board committees that are responsible for governance and risk, compensation, audit, strategy and investment. In addition, there should be development and implementation of a vision-to-values cultural manifesto that all current and future employees of Wahed live by.”

Scott Levy, CEO of Bedford Row Capital, a London-based fixed income structuring firm, said that the actions by the SEC against Wahed Invest should be taken seriously and are clear and acute. “This could be interpreted as a turning point,” he said. “They [Wahed] have a significant task of restoring trust.”

What are the lessons for Wahed?

In an email to Salaam Gateway, Wahed maintains that it does have a purification process and issues reports on them.

“The SEC charge here does not allege any failure in Wahed’s Sharia-compliance, but is only a US law allegation that existing written policies weren’t ’sufficient’ as the SEC understood our purification processes,” the company said. “The SEC does not determine Sharia-compliance for investment advisors and its allegation does not purport that it does so for Wahed.”

Wahed said that it does and always has had internal written policies regarding Sharia-compliance and has built Sharia-compliance in to the foundation of how the firm operates.

“Since its inception, Wahed's Sharia-compliance has been determined through rigorous review by its Sharia advisors and independent Sharia boards who, while not reviewing for US law matters, have never questioned the sufficiency of Wahed’s policies or real operational practices and have consistently certified to our Sharia-compliance,” the company said.

Wahed said it feels confident that its governance structure put it in a better place and it continues to actively respond to regulatory needs. It said that since 2018 it has dedicated significant resources to increase its oversight regime to address the regulatory environment including risks, legal and compliance functions.

“To the extent applicable and as the allegations mostly deal with activities from 2018, Wahed has already addressed most of the regulator's valid concerns that were raised during this process,” the company said. “[For example], in its most recent fund launch, Wahed ensured that current robo-advisory clients were notified well in advance of launch that their portfolios would be soon partially invested in the new fund.”

Wahed also said it increased its global risk and compliance standards and both personnel and oversight from the board reflects this now. It said whilst the SEC’s charges were not a function of any corporate governance shortcoming, it has taken this opportunity to further expand and deepen the maturation of its governance systems, which were already in progress over the last several years of its growth.

“This includes expansion in personnel and real-time capabilities, and the firm's group board of directors has already changed in 2020 and 2021, adding some directors with specific experience necessary for tech firms,” said Wahed.

Launched in 2017, Wahed is considered one of the most successful Islamic economy start-ups. Its portfolio includes its two ETFs in the US and halal workplace, pension portfolios for UK employees. Wahed has a presence in nine jurisdictions including operating licences in the US, UK and Malaysia. In June 2020, Wahed secured $25 million in a funding round led by the VC arm of Saudi Aramco. Wahed said it has over 250,000 customers globally, as of January 2022.

Bedford Row Capital’s Levy said that Wahed set an example of what can be possible in Islamic fintech and showed the path for others. [However], it also showed what happens when you have gaps and become overstretched,” he said. “It should give fintechs and other Islamic start-ups a lesson of what needs to be done in terms of compliance and reporting. As well as that it could give an opportunity to newer fintechs of how they will do things differently.”

Lessons for Islamic fintechs and start-ups

A key lesson for all Islamic start-ups is that they comply not only with Sharia but also with local laws and regulations.

“Islamic fintech or Islamic orientated start-ups mostly have global ambitions,” said Reza Jaufeerally, a former lawyer and CEO of noHunger, a Luxembourg-based social enterprise start-up. “They should abide by the requirements of the various regulators of the jurisdictions where they intend to operate.”

Paul Kayrouz, Head of FinTech & Emerging Technologies at PwC Middle East, said that it is also important for Islamic fintechs and Islamic oriented start-ups to have adequate policies and controls to ensure that their investment activities and service offerings remain Sharia compliant on an ongoing basis.

“In asserting themselves as being Islamic fintechs and Islamic oriented start-ups, it would be mandatory that they ensure that they are Sharia compliant, failing to do so will be construed as misleading customers,” he said.

One practitioner who covers both Islamic finance and fintech for a GCC-based financial centre, said that fintechs need to be more diligent when it comes to compliance and governance.

“The best way to learn is from others mistakes, this is a free lesson for the rest,” he said. “Most fintechs operate in a regulated environment in one way or another, understanding the regulatory framework and having the proper governance internally to abide by these regulations is of utmost importance and is an integral part of the success of fintechs.” 

Lessons for customers and investors

Perhaps one of the biggest lessons for other Islamic start-ups will be the importance of gaining, sustaining and maintaining customer and user trust in a product or service.

Blake Goud, CEO of the RFI Foundation said that it's hard for investors and customers to understand how to react to a regulatory action like this, but it is likely to prompt questions about what happened, what impact did it have on customers, and what was done to fix the situation.

“It's never good for a business to have regulators identify deficiencies leading to financial penalties, and customers should try to understand the answers to these questions to see if it's an issue that happened and was corrected, or if it's evidence of systematic issues with the business' culture,” he said.

Meanwhile, the practitioner at the GCC financial centre said that it would be unfair for the Wahed scenario to have a negative impact on other Islamic fintechs and start-ups from an investor perspective.

“The incident could drive investors to pay more attention to details pertaining to compliance and governance when evaluating potential projects, but shouldn’t impact their appetite for the sector as this doesn’t impose a fundamental challenge,” he said.

PwC’s Kayrouz said that investors should review documentation of Islamic fintechs to ensure that their investment activity is Sharia compliant and that they have processes to ensure such compliance continues.

“To adapt to this, Islamic start-ups should provide investors with their documentation evidencing how they are Sharia compliant and how they shall remain Sharia compliant going forward,” he said.

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