Untitled Texas Attorney General Opinion

THE ATTO~RNEY GENERAL
OIF TEXAS
0cl:ober24, 1986
Honorable 0. H. "Ike" &rrj.s Opinion No. JM-570
Chairman
Economic Development Commit,tee Re: Investment of municipal
Texas State Senate funds in money market mutual
P. 0. Box 12068, Capitol Station funds
Austin, Texas 78711
Dear Senator Harris:
Your letter requesting;the opinion of this office reads:
Pursuant to various statutes, cities in Texas
are authorized to invest certain of their muni-
cipal funds in obligations or securities of the
United States. See, e. ., articles 1182-g,
12693-3, and 2561. V.T.C.S. The city of Arlington
has concluded, aEter due research and considera-
tion, that the investment of funds in government
securities through the vehicle of a money market
mutual fund WMMI~) would be most desirable. Your
The type of MMNF or 'open-end investment
company' which wcw.ldbe eligible for this type of
investment is s],ecifically designed for use by
banks, fiduciaries and custodians of public funds.
The MMMF would ::nvest only in short-term United
States Treasury ,&linations which mature in less
than one year.* An investor such as the city would
own an individe;-pro rata interest in the port-
folio of short-te;m obligations owned by the fund.
This types of mur;al fund is registered with the
Securities and Exchange Commission (SEC) under the
Investment Company Act of 1940 and their shares
are registered wder the Securities Act of 1933.
A fund for U.S. Treasury obligations would invest
only in instruments issued by the United States
government or it3 agencies. The securities pur-
chased by the fund must be held by a qualified
p. 2535
Honorable 0. H. "Ike" Harris - Page 2 (JM-570)
bank or other institution acting as custodian of
the government securities which are in fully
negotiable form ~without restrictions, are in-
spected periodically by independent public
accountants and me subject to inspection by the
SEC. All employt!esof the fund having access to
the securities mil:stbe bonded. The SEC can and
does inspect.the books and records and regulate
the accounting policies and principals of the fund
and all financia:.statements of the fund must be
prepared by independent public accountants.
The ownership of government obligations through
the vehicle of an MMMP as opposed to ownership of
individual securities is advantageous to the city
in several respects. It first provides the city
with a more effjcient cash management tool than
does traditional ownership of individual securi-
ties. Because mnership through a fund allows
both the investment and withdrawal of funds
without the purchase or sale of the underlying
governmental securities, the city enjoys a
liquidity of its investment which enables it to ?
better manage its financial affairs and earn an
appropriate rate of return. In addition, the use
of a fund for investment in governmental obliga-
tions represents a reduction in the risk inherent
in any investme=; and, very importantly, reduces
the cost to the #city for its investment trans-
action. In short, it would appear that investment
in an MMMP offers .a11of the security of ownership
of individual securities but further provides
other advantages not available through individual
ownership. (Empha;sisadded).
The city of Arlington is a home rule city; it may incorporate in
its charter and enact by ord.inanceany provision that is not inconsis-
tent with the general law;3 of the state or with the constitution.
Tex. Const. art. XI. 55; V.T.C.S. art. 1165. See 40 Tex. Jur. 2d
Municipal Corporations 1326 (1976). But such cxes are precluded
from entering a field of legislation occupied by general legislative
enactments. Prescott v. City of Borger, 158 S.W.2d 578 (Tex. ci~.
APP. - Amarillo 1942, writ cef'd). See also City of Baytown v. Angel,
469 S.W.2d 923 (Tex. Civ. Ap:p.- Houston [14th Dist.] 1971, writ ref'd
n.r.e.).
Of the three statutes mentioned by your letter, article 1182g,
V.T.C.S., is applicable o,n:.y
to home rule cities having a population
of 900,000 or more accord,Lug to the most recent federal census, a -.
category that does not inc:Ludethe city of Arlington. Article 2561,
P. 2536
Honorable 0. H. "Ike" Harris - Page 3 (m-570)
V.T.C.S., applicable to home rule cities as well as others, states in
subsection (b):
(b) Unless espressly prohibited by law or
unless it is in contravention of any depository
contract between a city, town, or village and any
depository bank. the governing body of a city,
town, or village may direct the treasurer of the
entity to:
(1) withdraG any amount of funds of the
entity that am deposited in a depositqry and
that are not. required immediately to pay
obligations o:i the entity or requried to be
kept on dep0si.tunder the terms of the deposi-
tory contract; and
(2) invest those funds in direct debt
securities of-the United States. (Emphasis
added).
Article 12695-3, V.T.C.S., applies to "all political subdivisions,"
which include home rule cities. It reads:
All political subdivisions of the State of
Texas which have balances remaining in their
accounts at the end of any fiscal year may invest
such balances in Defense Bonds or other obliga-
tions of the Uzfed States of America; provided.
however. that ti& such funds are needed the
obligations of 1:h.eUnited States in which such
balances are invested shall be sold or redeemed
and the proceed;3 of said obligations shall be
deposited in the: accounts from which they were
originally drawn. (Emphasis added).
The Texas Legislature 'has by these statutory provisions enacted
general legislation controlling the type of securities in which the
funds of home rule cities may be invested. The investment practices
of the city of Arlington, t,obe legally authorized, must be consistent
therewith. Prescott v. City of Borger, m. Cf. V.T.C.S. art.
2549(c) (county investment%thority): V.T.C.S. artn413(34c) (rules
gove%ng lpcai funds); V.T.C.S. arc. ~2525, 54(a)(4) (state investment
authority).
1. Contemporary amendments to article 2525, V.T.C.S., were saved
from repeal by section 2 cf Acts 1985, 69th Leg., ch. 240, at 1204,
enacting the Treasury Act. .-
See Acts 1985, 69th Leg., ch. 71, at 488.
p. 2537
Honorable 0. H. “Ike” Harri;;- Page 4 (m-570)
A “money-market fund” can be generally described as a mutual fund
which typically invests in :short-termdebt instruments such as govern-
ment securities, commercial paper, and large denomination certificates
of deposit of banks. A “mutual fund” is a type of investment company
which continuously offers shares to the public and stands ready to buy
back shares whenever an investor wishes to sell. See Handbook, U.S.
Securities and Exchange Colmnission,What Every Invzor Should Know
at 29 (1986). As your letter notes, a mutual fund is an “open-end
investment company”:
An open-end inrestment company -- usually known
as a mutual fund ‘-- is a company with a managed
portfolio of securities that will buy back shares
from investors whenever the investor wishes to
sell. The redemption price depends upon the value
of the company’s portfolio at that time (the ‘net
asset value’). There is no secondary trading
market for the sbures of such companies.
When the selling price of the shares of an
open-end company includes a sales charge, the
company is known as a load fund. Shares of such
companies may be purchased through broker/dealers --.
who receive part XE the sales charge. An open-end
investment company is known as a no-load fund if
the selling price of its shares does not contain a
sales charge. Shares of such a fund usually may
be purchased directly from the investment company
or its underwriter. Broker/dealers who sell
shares of such a :ompany may charge only a nominal
fee for their services.
Id. at 22. See Board of Governors of the Federal Reserve System v.
Investment Company Institut;, 450 U.S. 46, 51 (1981).
While it may be true as an abstract matter that an investor in
such a fund.owns an undivided pro rata interest in the portfolio of
short-term obligations owned by the fund, it is true only in the same
sense that an investor in the stock of a manufacturing concern can
be said to own an undivided pro rata interest in the machinery,
buildings, and other assets of the manufacturer. The investor can
exercise no personal control over the portfolio of the fund or its
disposition, and has no ri&t to reduce to possession any part of it
for safekeeping or for any other purpose.
As Professor Frankel says in 1 Frankel, The Regulation of Money
Managers, A 12 at 5 (1978):
?
Investment coxpanies are designed to offer
small investors expert management and diversifica-
tion by pooling wsall investments and entrusting
p. 2538
.
.
Honorable 0. H. "Ike" Harris - Page 5 (m-570)
them to one mansger. Investment companies are
sponsored and promoted by members of the
securities and iuvestment industries, not by the
small investors. . . .
. . . .
The small investor benefits from management,
diversification, and economies of scale. On the
debit side, he has no control or very little
control over his investment, and he has little
means of judging the value of the services.which
he receives.
The suggestion that the use of such a fund for investment in
government obligations represents a reduction in the risk inherent in
any investment is subject to question. The investor in such a fund
assumes risks as to the fi'lr~lity,accountability and expertise of the
fund managers as well as the financial stability and responsibility of
the entities whose obligations are represented in the portfolio of the
fund. But that is not the issue. We cannot base our answer on anti-
cipated advantages of such an investment. Instead, we must determine
whether ownership interests in such a fund constitute 'direct debt
securities of the United States" within the meaning of article
2561(b), V.T.C.S., or "obligations of the United States of America"
within the meaning of article 1269j-3, V.T.C.S.
A "government security,"is defined by the Investment Company Act
of 1940 to be
any security issued or guaranteed as to principal
or interest by the United States, or by a person
controlled or supervised by and acting as an
instrumentality of the Government of the United
States pursuant to authority granted by the
Congress of the United States; or any certificate
of deposit for any of the foregoing.
15 U.S.C. 580a-2(a)(16). It is noteworthy that under the Texas
Securities Act, article 581-1, et. seq., V.T.C.S., a direct sale of
government securities to a purchaser is an exempt transaction, but the
sale of an interest in z. mutual fund dealing in such government
securities is not. -See V.T.C.S. art. 581-5. subset. M.
In Bankers Farm Mortgage Company v. United States, 69 F. Supp. 197
(U.S. Ct. Cl. 1947). cert. denied, 331 U.S. 831 (1947). a case which
arose before the Investmenf:Act of 1940 was enacted, it was contended
that bonds issued by the hankers Joint Stock Land -Bank of Milwaukee
were obligations of the United States because the bank was organized
- and existed under a federal charter pursuant to an act of Congress
which declared such bonds "instrumentalities of the United States
p. 2539
,
Honorable 0. H. "Ike" Earrib - Page 6 (x4-570)
Government" and exempt from taxation. The plaintiff was a corporation
formed to buy up the bank's outstanding bonds after the bank had
defaulted on their payment and had become insolvent.
The Bankers Farm MortSage Company court observed that the bank,
which loaned money to far&s for profit, was organized for private
gain and that all its capititlwas furnished by private investors. The
Court held the bonds not to be obligations of the United States,
saying:
Neither the statute nor the bonds contain any
express promise by defendant [the United States]
to pay the bonds, or to become liable for any
other obligation or debt of the bank, and we think
no such obligation can be inferred or implied in
the circumstances,
69 F. Supp. at 202.
Open-end money market investment companies (mutual funds) are
organized for private gain with capital provided by private investors,
and the United States has made no express or implied promise to be
liable, or to become liable, for the obligations of such companies
notwithstanding that the caq'anies themselves may invest in government
securities and are subject to federal regulatory control. See 15
U.S.C. §80a-1 et seq. (the Investment Company Act of 1940)FThe
investment of funds in obligations or shares of such companies (which
companies are not chartered t'yCongress or made tax exempt and are not
by Congress made instrumentalities of the government) is not=
investment of funds in obligations of the United States of America
within the meaning of article 1269j-3, V.T.C.S., nor an investment in
direct debt securities of the United States within the meaning of
article 2561(b)(2), V.T.C.S.
A similar question wa.s considered by this office in Attorney
General Opinion .JM-23 (158,3). There, a statute (since amended)
authorized counties to invest idle funds only in "direct debt
securities of the United !;t:ates.11 See V.T.C.S. art. 2549(c). The
question was whether Dallas County might utilize "repurchase agree-
ments" involving securities of the United States for short term
investments, &, whether an investment in such repurchase agreements
was an investment in "direc,:debt securities of the United States.'
The opinion concluded that an investment in such repurchase
agreements was not the stat:utory equivalent of investing in direct
debt securities of the United States. We reach an analagous
conclusion here. Cf. Attorney General Opinions MW-343 (1981); MW-224
0980). In our opinion' tht! existing statutes of this state do not
authorize the city of Arlington to invest its funds in a money market
mutual fund regulated by the federal government, even though the fund
deals solely in obligations of the United States.
p. 2540
Honorable 0. H. "Ike" Harris - Page 7 (JM-570)
As a matter of interest, two proposals to expressly authorize the
investment of public funds in money market mutual funds were defeated
by the Sixty-ninth Legislature in 1985. See S.B. No. 766, 69th Leg.
(1985); H.B. No. 2078, 69th :Leg. (1985). -
SUMMARY
The existing statutes of this state do not
authorize the city of Arlington to invest its
funds in a money market mutual fund dealing solely
in obligations of the United States.
JACK HIGHTOWER
First Assistant Attorney General
MARY KELLER
Executive Assistant Attorney General
RICK GILPIN
Chairman, Opinion Committee
Prepared by Bruce Youngblocd
Assistant Attorney General
p. 2541