May 5,1999

Mr. Charles L. Dunlap Executive Director Teacher Retirement System of Texas 1000 Red River Austin. Texas 78701 Opinion No. JC-0043

Re: Permissible investments of Teacher Retirement System and related questions (RQ-1174)

Dear Mr. Dunlap:

On behalf of the Board of Trustees of the Teacher Retirement System (the “Board”), you inquire about the Board’s authority to invest the retirement system’s trust fund. You first inquire about the scope of the term “securities” in article XVI, section 67 ofthe Texas Constitution, which provides that the assets of the retirement system are to be invested in “such securities as the board may consider to be prudent investments.” We reject the conclusion of Attorney General Opinion MW-152 (1980) and Letter Opinion No. 94-052 that “securities” within this provision consists of those investments thatthe federal Securities andExchange Commission orthe State Securities Board has determined to be asecurity within the regulatory statutes they administer. Instead, we conclude that “securities” is to be defined by reference to chapter 8 of the Texas Business and Commerce Code, which defines securities for investment purposes.
You also inquire about the authority of the Board under sectibn 825.301(b) of the Texas Government Code to delegate authority to manage certain investments to outside managers. We conclude that the Board of Trustees lacks authority to delegate its discretionary authority over investments to private investment managers.
I. Introduction

Article XVI, section 67(b)(l) of the Texas Constitution provides that the “legislature shall establish by law a Teacher Retirement System of Texas to provide benefits for persons employed in the public schools, colleges, and universities supported wholly or partly by the state.” See TEX. CONST. art. XVI, 5 67(b)(2) (similar provision applicable to the Employees Retirement System for officers and employees of the state). The amount contributed by a person participating in the Teacher Retirement System of Texas (“TRS”) “shall be established by the legislature but may not be less than six percent of current compensation.” Id. 5 67(b)(3). See TEX.GOV’T CODEANN. 5 x25.402(5) (Vernon 1994) (rate of contribution for retirement system members is 6.4 percent of member’s annual compensation). “The amount contributed by the state may not be less than sixMr. Charles L. Dunlap - Page 2 (X-0043)

percent nor more than 10percent ofthe aggregate compensation paid to individuals participating in the system.” TEX.CONST.art.XVI, $67(b)(3); see TEX.GOV’T CODE ANN.5 825.404(a) (Vernon 1994) (state contributes to retirement system an amount equal to eight percent of aggregate annual compensation of all retirement system members during that fiscal year).
The TRS trust fund, which isheld in trust forthe benefit ofmembers, TEX.CONST. art.XVI, 567(a), exceeds $60 billion in value. Brief from Teacher Retirement System ofTexas to Office of Attorney General 15(Sept. 18,199s) [hereinafter TRS Brief 9/18/98]. Approximately sixty percent ofthe portfolio isinvested in equity securities traded on domestic and foreign public exchanges, with the bulk of the remainder invested in fixed-income instruments such as corporate and government bonds. Id. at 14. “Depending on the current market values of the publicly-traded securities in the portfolio, between 1and 3%oftheportfolio isinvested inreal estate mortgages orreal estate accrued through foreclosure or deed in lieu of foreclosure and alternative investments such as the Texas Growth Fund.” Id.; see TEX.CONST. art. XVI, 5 70 (establishing Texas Growth Fund to make investments “directly related to the creation, retention or expansion ofemployment opportunity and economic growth in Texas” and authorizing investment in growth fund of TRS fund and certain other constitutionally established trust funds).

As background to your questions, you refer to the “Report to the Legislative Audit Committee Regarding the Investment Program and Practices of the Texas Teacher Retirement System,” prepared by Independent Fiduciary Services, Inc. (“Fiduciary Services”), and submitted to the Legislative Audit Committee in October of 1996. The Report suggests that the Teacher Retirement System consider investing in “alternative” investments, high yield bonds, and financial futures contracts as a means of diversifying its investments. “Alternative investments,” as commonly defined, include “a wide range of disparate strategies and types of assets, including emerging market securities (i.e., debt and equity of companies based in underdeveloped countries), private domestic equity (including venture capital and mezzanine financing), international private equity, leveraged buy-out funds, distressed securities (issued by companies which the investment manager seeks to “turn around”), oil and gas programs, timberland and farmland.” INDEPENDENT FIDUCIARY

SERVICES,

INC., REPORT

TOTHELEGISLATIVE AUDITCOMMI~EE REGARDING THE INVESTMENTPROGRAMANDPRAC~CESOFTHETEXASTEACHERRETIREMENTSYSTEM 146-47 (1996) [hereinafter IFS Report]. A State Auditor’s report on investment practices at certain state investing entities defines “alternative investments” as follows:

Investment opportunities which have not been identified by traditional public equity or fixed income capital markets. Also may be defined as private, non-traditional, illiquid investments.

. . Alternative investments areaccomplished almost exclusively through private offerings of debt or equity interests, and are often made through entities organized as limited partnerships. Examples of alternative investments include international and emerging market stocks, hedge funds, event driven strategies+ well asilliquid equityMr. Charles L. Dunlap - Page 3 (X-0043)

investments such as venture capital, mezzanine financing, private equity and buy-out investing, real estate, and oil and gas.
OFFICE OFTHESTATE

AUDITOR,

A REVIEW

OFCONTROLS

OVER INVESTMENT

PRACTICES

ATSIX MAJORSTATE

INVESTING

ENTITIES177 (Nov. 1996) [hereinafter Review]; SW also id. at 180 (“mezzanine financing” is investment in the subordinated debt ofprivately owned companies, the debt holder participating in equity appreciation through conversion features such asrights, warrants,
or options).

The Independent Fiduciary Services report also recommends that the Board “promptly and expressly” decide whether to renew the mortgage loan program, setting out certain fundamental issues the Board should address in making this decision. IFS Report supra, at 42. In deciding whether and in what form to renew mortgage lending, “the Board should consider retaining a nationally-prominent strategic real estate consulting firm.” Id. at43.

The report states that the review was conducted primarily from an investment perspective and it is not expressing an opinion as to the legality of the measures it recommends. Id. at 5. Following a discussion of the merits of delegating investment authority to outside investors, the report recommends that “the Board seek to obtain appropriate clarification or support (whether through legislation, constitutional amendment, ifnecessary or otherwise), permitting it to delegate investment authority.

.” Id. at 26. Thus, the report does not assume that TRS has present authority to implement itsrecommendations. SeealsoReview supru, at26 (suggesting that TRS and ERSjointly request attorney general opinion regarding their ability todelegate investment authority).

II. What is the meaning of usecurities” in article XVI, section 67(a)(3) of the Texas Constitution?

Your first question is as follows:

1. Forpurposes ofdetermining the scope ofTRS’ constitutional and statutory investment authority, is the definition of “securities” for regulatory purposes, e.g.,under The Securities Act, TEX. REV. CIV. STAT. ANN. art. 581-4(A) (Vernon Supp. 1998), the sole and exclusive definition upon which TRSmust rely? Ifnot, may TRSrely
on the concept that asecurity isthe evidence ofdebt or of ownership obtained as a result of the outlay or commitment of money for the purpose andwith the expectation ofearning revenue, income orprofit from its employment in a common (separate) enterprise?
The term “security” isnot defined inthe constitutional provision, nor isitdefined by a statute applicable to TRS. Section 825.301 ofthe Government Code authorizes the TRS Board to “invest and reinvest assets ofthe retirement system without distinction asto their source in accordance with Section 67, Article XVI, Texas Constitution” and expressly provides that the Board may invest inMr. Charles L. Dunlap - Page 4 (X-0043)

a list of specific securities: “[Olbligations issued, assumed, or guaranteed by the Inter-American Development Bank, the International Bank forReconstruction and Development (the World Bank), the African Development Bank, the Asian Development Bank, and the International Finance Corporation.” Government Code section 825.301(a) also provides that the Board’s “[ilnvestment decisions are subject to the standard provided in the Texas Trust Code by section 113.056(a), Property Code,” which states the prudent person rule. See Hoenig & Union Nat ‘1 Bank v. Texas Commerce Bunk, 939 S.W.2d 656,661 (Tex. App.-San Antonio 1996, no writ).

Prior opinions of this office have advised TRS that the term “securities” in the Texas Constitution, article XVI, section 67(a)(3), is defined according to the definition ofthis term in the federal and state securities regulatory acts. SeeTex. Att’y Gen. Op.No.MW-152 (1980), Tex. Att’y Gen. LO-94-052. We examine this prior advice in light of an analysis of article XVI, section 67 of the Texas Constitution.
A. Historv of article XVI. section 67 of the Texas Constitution

Article XVI, section 67 of the Texas Constitution was adopted in 1975 by the voters’ approval of a resolution that consolidated nearly all constitutional provisions relating to state and local retirement systems. CONSTITUTION OFTHE STATE OFTEXAS,Amendments Adopted in 1973-1975, 1975 Tex. Gen. Laws LXXV,XLVII, LXXXII-LXXXIII.

The constitutional provision sets out the following duties of trustees of statewide retirement systems:

[e]ach statewide benefit system must have aboard of trustees to administer the system and to invest the funds of the system in such securities asthe board may consider prudent investments. Inmaking investments, aboard shall exercise thejudgment and care under the circumstances then prevailing that persons of ordinary prudence, discretion, and intelligence exercise in the management oftheir own affairs, not in regard to speculation, but in regard to the permanent disposition oftheir funds, considering theprobable income therefrom
as well asthe probable safety oftheir capital. The legislature by law may further restrict the investment discretion of aboard.

TEX. CONST. art. XVI, 5 67(a)(3). This provision applies to the trustees of the Employees Retirement System (“ERS”) aswell asthe trustees ofthe Teacher Retirement System. Itestablishes two important limitations for statewide retirement systems-the funds are to be invested in

“securities” and these investments are to be made according to the “prudent person” standard that it sets out.
Local retirement systems are not subject to the constitutional constraints that apply to statewide retirement systems. Article XVI, section 67(c)provides that the “legislature shall provide by law” for creation of abenefits system by a city or county for its officers and employees and for statewide benefit systems available to the officers and employees of cities, counties, and otherMr. Charles L. Dunlap - Page 5 (X-0043)

political subdivisions. TEX.CONST. art. XVI, $ 67(c). Thus, the constitution does not limit local retirement systems to investing in “securities,” nor does this provision state the standard of care applicable to trustees in making investment decisions for local retirement systems. The legislature may address these aspects oflocal retirement systems absent the constitutional constraints applicable to laws on statewide retirement systems. See Williams v.McKnight, 402 S.W.2d 505 (Tex. 1966) (legislature may not enact laws in conflict with the constitution); Jones v. Williams, 45 S.W.2d 130 (Tex. 1931) (legislature may enact any law not in violation of state or federal constitution).

The constitutional provision that had formerly governed the investment ofTRS assets, was repealed by adoption ofthe same resolution that proposed article XVI, section 67. SeeTEX.CONST. of 1965, art. III, $48b (repealed 1975). The former provision authorized the TRS Board to invest the assets of the System in specific and narrow categories of investments: bonds, notes or other evidences of indebtedness of the United States, the State of Texas, or apolitical subdivision of the State of Texas, corporate stocks, bonds, notes, and other evidences of indebtedness, and land, a building, and equipment for the TRS offices. Tex. S.J. Res. 27, 59th Leg., R.S., 1965 Tex. Gen. Laws 2201. Article XVI, section 67 authorized the Boards ofTRS and ERS “to invest the fimds of the system in such securities astheboard may consider prudent investments,” thus broadening their investment authority while including strict safeguards for fund security. TEX.LEG.COUNCIL, 2 PROPOSED

CONSTITUTIONAL

AMENDMENTS

ANALYZED

3(Apr.22,1975); seealso COMM. ON CONST. REV.,BILL

ANALYSIS,

Tex. S.J.R. 3,64th Leg., R.S. (1975). Given the nature ofthe TRS funds and the constitutional language, the underlying purpose ofthe constitutional provision must necessarily be to safeguard the funds and maximize returns to provide teachers with the maximum retirement benefits. See Woods v.Reilly, 218 S.W.2d 437,442 (Tex. 1949) (purpose of former art. III, 548a ofthe Texas Constitution of 1936(repealed 1965)wastoprovide security forpublic school teachers and provide incentive for qualified persons to become and remain teachers).

Article XVI, section 67,represents adevelopment ofthe categorical approach to investments found in its predecessor, former article III, section 48b ofthe Texas Constitution, but it still places limits on the class of investments permissible for retirement system funds. For example, in 1980, this office advised TRS that it could not invest in real estate, because real estate was not a security within the constitutional provision. Tex. Att’y Gen. Op.No.MW-152 (1980). In 1982,alegislative study of public retirement systems commented as follows on the attorney general’s opinion:

Investment of the [TRS] fund is governed by a provision in the Texas [Clonstitution which specifies that the trustees are responsible for investing system assets in such securities as are deemed prudent. This version of the ‘prudent person rule,’ as interpreted by the State Attorney General, effectively precludes investments in such categories asequity real estate ortangible assets which might, depending on the nature and form ofthe investment and otherMr. Charles L. Dunlap - Page 6 (JC-0043)

circumstances otherwise be deemed prudent by a board of trustees working under apure version of the prudent person rule.

SELECT COMM. ON PUB. RETIREMENT

SYSTEMS,

F&PORT TOSPEAKER

AND MEMBERS

OF THE TEXAS HOUSE OF REPRESENTATIVES

68~~ LEGISLATURE

52 (Oct. 1982)(emphasis in original) [hereinafter PRS Report]. A “pure” version of the “prudent person rule” would allow a board of trustees to invest funds limited solely by the “prudent person rule.” See generally HOUSE RETIREMENT

& AGINGCOMM.,BILL ANALYSIS,

Tex. S.J.Res. 6, 72d Leg., R.S. (1991). The report recommended to the legislature the removal of specific constitutional and statutory restrictions on the investment ofthe assets ofERS and TRS and the grant ofinvestment authority in the form ofthe prudent person rule as defined by common law. PRS Report supra, at 54. The Sixty-eighth Legislature did not propose an amendment to article XVI, section 67,but itdid adopt provisions authorizing the trustees of TRS to “contract with private professional investment managers to assist the board in investing the assets ofthe retirement system.” Act ofMay 29,1983,68th Leg., R.S., ch. 926,s 4, 1983Tex. Gen. Laws 5099,510O (now codified as TEX.GOV’TCODEANN. § 825.301(b) (Vernon 1994)).

In 1991the legislature proposed an amendment to article XVI, section 67 that would have substituted a“pure” version ofthe “prudent person” rule forthe present language, but itwasrejected by the voters. The amendment, proposed by Senate Joint ResolutionNo. 6,would have deleted from article XVI, section 67, the language authorizing the trustees “to invest the funds of the system in such securities as the board may consider prudent investments,” and provided them authority “to invest the funds of the system in such manner as the board may consider prudent.” Tex. S.J. Res. 6, 72d Leg., R.S., 1991 Tex. Gen. Laws 3520 (emphasis in original). The bill analysis for the proposed amendment provides the following background:

Over several legislative sessions, the Employees Retirement System (ERS) and the Teacher Retirement System (TRS) enabling laws have been amended to remove statutory lists of legal investments for those funds. However, an Attorney General’s opinion (MW-152) has held that the Constitution’s use of the word

“securities” restricts the systems from certain investments.
HOUSERETIREMENT&AGINGCOMM.,BILLANALYSIS,T~~.S.J.R~~.~,~~~L~~.,R.S. (1991). Thus, article XVI, section 67(a)(3) has notbeen amended since itwas adopted in 1975. Wenote, however, that a pending resolution proposes an amendment to article XVI, section 67(a)(3) of the Texas Constitution that would delete the term “securities” and authorize the board of a statewide system

“to invest the funds of the system in such investments as the board may consider prudent investments.” Tex. H.R.J. Res. 9, 76th Leg., R.S. (1999) (proposing a constitutional amendment relating to investment of the Texas Growth Fund and by statewide public retirement systems) (emphasis added).Mr. Charles L. Dunlap - Page 7 UC-0043)

B. Rules of constitutional construction

With the history of article XVI, section 67 in mind, we attempt to define “securities” as it appears in this constitutional provision. The provision itself does not define the term “securities,”
nor are there any judicial decisions construing this term. The statute implementing the TRS investment authority, Government Code section 825.301(a), essentially restates the constitutional authorization and therefore provides us with no guidance in defining terms used in article XVI, section 67. See generally Hill County v. Sheppard, 178 S.W.2d 261 (Tex. 1944) (court looks to statute creating office of “criminal district attorney” to construe that term in article V, section 21 of Texas Constitution); Aerospace Optimist Club v. TexasAlcoholic Beverage Comm ‘n,886 S.W.2d 556,560 (Tex. App.-Austin 1994, no writ) (looking to bingo statute’s definition of “proceeds” to define that term in article III, section 47, Texas Constitution).

In construing the state constitution, a court will give effect to its plain language, also considering the purpose of the provision, its historical context, and the collective intent of the framers and the people who adopted it. Republican Party v.Die&, 940 S.W.2d 86,89 (Tex. 1997); Con v. Robinson, 150 S.W. 1149, 1151 (Tex. 1912) (proceedings of legislative body framing provision may be examined to aid in resolving questions of construction). SeeAerospace Optimist Club, 886 S.W.2d at 560 (we “look to other sources for instruction asto the meaning and purpose” ofthe term, including legislative interpretations). The prior state ofthe law may be examined. Cox, 150 S.W. at 1156. The constitution must be read as a whole and ambiguities may be resolved by reference to other parts ofthe constitution. Collingsworth County v.Allred, 40 S.W.2d 13,14 (Tex. 1931). Thus, aclause that, standing by itself, might seem ofdoubtful import may yetbe made plain by comparison with other clauses or portions of the same instrument. Purcell v. Lindsey, 314 S.W.2d 283 (Tex. 1958); Snelson v.Murray, 252 S.W.2d 720 (Tex. Civ. App.-El Paso 1952, writ ref d n.r.e.).
The meaning of constitutional provisions may be ascertained by reference to the common law. Trimmier v. Carlton, 296 S.W. 1070, 1079 (Tex. 1927) (delegation of legislative powers). A dictionary may be consulted to determine the meaning of a word employed in a statute. Texas & P.Ry. Co. v.Railroad Comm’n, 150SW. 878,881 (Tex. 1912);see Booth v. Strippleman, 61 Tex. 378,3 82(1884) (rules analogous tothose goveming interpretation ofstatutes andprivate instruments
are referred to in construing constitutional provisions). However, one word may beused to express different ideas, Oden v. Gates, 24 S.W.2d 381 (Tex. 1930), and this is true ofthe word “securities.” Bahre v.Pearl, 595 A.2d 1027, 1035 (Me. 1991) (definitions of “security” in securities regulatory statute and Uniform Commercial Code article 8 are separate and distinct). The meaning of a word must be determined according to the context, subject matter, and evident intent ofthe framers and the people. Oden, 24 S.W.2d at 382. When one of two equally reasonable constructions of a constitutional provision will give rise to fewer or less complicated questions in its application, that constructionshouldbe favored. Thomnsv. Creuger, 107S.W.2d705,710 (Tex. Civ. App.-Eastland 1937, writ dism’d); see also Moore v. Edna Hosp. Dist., 449 S.W.2d 508, 526 (Tex. Civ. App.Xorpus Christi 1969, writ ref d n.r.e.). When, in addition, one of the two constructions will,Mr. Charles L. Dunlap - Page 8 (X-0043)

to a greater degree, effect the purpose of the provision, such construction should be adopted. Creager, 107 S.W.2d at 710.

C. Common-law and dictionarv definitions of “securities”

The TRS argues that “securities” within the constitutional provision should be defined by reference to the common law and to dictionary definitions, stating that the definition of securities found in the regulatory statutes is too uncertain to provide the exclusive source for determining its constitutional investment authority. TRS Brief 9/l S/98,at49. “Securities,” asTRS defines theterm on the basis ofthe common law and dictionaries, would include any evidence of debt, property, or ownership, and evidences of obligations to pay money or of rights to participate in earnings and distribution of corporate, trust, or other property. Id. at 3-4. TRS suggests that cases interpreting the term “securities” in wills may be instructive, id. at 36, but we disagree. Such common-law definitions were developed to construe aparticular will, not to determine appropriate investments for apublic pension fund. SeeHuckubee v.Hansen, 422 S.W.2d 606,609 (Tex. Civ. App.Corpus Christi 1967,no writ) (considering whether “securities” incontext ofwill included savings account);
see also OceanAccident & Guarantee Corp.,Ltd. v.First Nat ‘I Bank, 84 S.W.2d 1111,1115 (Tex. Civ. App.-Galveston 1935, writ dism’d) (“securities” within bank burglary and robbery policy included loss ofjewelry held by insured as collateral security for loans). These common-law definitions do not apply to the term “securities” as used in article XVI, section 67.

In connection with its argument that dictionary definitions may be relied upon to construe

“securities,” the TRS brief cites Webster’s dictionary, which defines “security” as “an evidence of debt or ofownership (as a stock certificate or bond).” TRS Brief g/18/98, at 35 (citing WEBSTER’S NEW COLLEGIATE

DICTIONARY

1045 (8th ed. 1973) & MERRIAM-WEBSTER’S COLLEGIATE DICTIONARY

1056(10th ed. 1993)). Italso citesthe following definition of “securities” fromBlack’s Law Dictionary:

Stocks, bonds, notes, convertible debentures, warrants, or other documents that represent a share in a company or adebt owned by a company or government entity. Evidences of obligations to pay money or of rights to participate in earnings and distribution of corporate assets. Instruments giving to their legal holders rights to money or other property; they are therefore instruments which have intrinsic value and are recognized and used as such in the regular channels of commerce.
Id. at 35 (citing BLACK’S LAWDICTIONARY

1354 (6th ed. 1990)) (citation omitted).
TRS proposes an extremely broad definition of securities, one that would in effect remove any limitations on its investment authority imposed by the term “securities” and substitute aformula that is difficult to distinguish t?om the pure “prudent person” rule. In our opinion, “security” has a meaning that may not be swept away by such construction. A greatly broadened definition ofMr. Charles L. Dunlap - Page 9 (X-0043)

“securities” for purposes of article XVI, section 67, might give the TRS Board more ability to diversify its portfolio and place funds in novel investments, subject to the prudent person standard. In our opinion, however, such abroad definition would virtually delete the term “securities” from that constitutional provision. Wehave already noted that in 1982acommittee proposed the deletion of‘kecurities,” from article XVI, section 67,andthat in 1991the legislature proposed an amendment to the constitution deleting this term, only to have it defeated by the voters. Thus, the term

“securities,” with the limitations it places on the TRS investment authority, remains in the constitution.
Moreover, by comparing article XVI, section 67(a)(3) with certain other constitutional grants of investment authority, we can illustrate the limits that the term “securities” imposes on TRS’s power to invest the System’s assets. The 1988constitutional amendment that established the Texas Growth Fund and adopted article VII, subsection 5(d) and section 1lb of the Texas Constitution grants specific governmental entities broad investment authority over certain constitutional funds. Tex. H.R.J. Res. 5,7Oth Leg., 2d C.S., 1988Tex. Gen. Laws 942; Votes on Proposed Amendments to the Texas Constitution, 1875-May 1993, 1993 Tex. Gen. Laws 23 (Table following index) [hereinaflerVotesonProposed Amendments]. Before the 1988amendment was adopted, articleVI1, section 4ofthe Texas Constitution provided that the proceeds of selling lands set apart to the public free school fund must be used to purchase other land for the fund,

or the proceeds shall be invested by the treasurer, asmay be directed by the Board ofEducation

. ,in the bonds ofthe United States, the State of Texas, or counties in said State, or in such other securities, and under such restrictions as may be prescribed by law.

.
TEX. CONST.art. VII, 54 (amended 1883,1985,1995).

The voters’ approval in 1988ofHouse Joint Resolution No. 5established the Texas Growth Fund and authorized the Board of Regents of the University of Texas System and the State Board ofEducation to invest in the fund. SeeTex. H.R.J. Res. 5,7Oth Leg., 2d C.S., 1987Tex. Gen. Laws 942; Votes on Proposed Amendments supra, at23. Itmoreover broadened the authority ofthe State Board of Education to invest the assets of the Permanent School Fund. See TEX. CONST.art. VII, $55(d), 1lb; id. art.XVI, $70 (constitutional amendments approved by adoption 0fH.R.J. Res. No. 5). Subsection 5(d) ofarticle VII, asadopted by House Joint Resolution No. 5,provides as follows:

Notwithstanding any other provision of this constitution, in managing the assets ofthepermanent school fund, the State Board of Education may acquire, exchange, sell, supervise, manage, or retain, through procedures and subject to restrictions it establishes and in amounts it considers appropriate, any kind ofinvestment, including investments inthe Texas growth fund created by Article XVI, Section 70, ofthis constitution, that persons ofordinary prudence, discretion, and intelligence, exercising the judgment and care under theMr. Charles L. Dunlap - Page 10 (X-0043)

circumstances then prevailing, acquire orretain fortheir own account in the management oftheir affairs, not in regard to speculation but in regard to the permanent disposition of their funds, considering the probable income as well as the probable safety of their capital.

TEX. CONST.art. VII, 5 5(d) (emphasis added).

Section llb of article VII provides similar authority for the Board of Regents of the University of Texas to invest the permanent university fund. The constitutional amendments allowed “the trustees of the Permanent University Fund (PUF) and the Permanent School Fund (PSF) to make any type of investment, subject solely to the prudent-person standard.” HOUSE RESEARCH

ORG., SPECIAL

LEGISLATIVE

REPORT,1988 CONSTITIJTIONAL AMENDMENTS,

19, 21 (1988). Article XVI, section 67(a)(3), in contrast, does not accord TRS equally broad authority to invest the teacher retirement fund.

D. “Securities” as defined bv statute
The definitions of “securities” we have found in the common law and in dictionaries are too broad to define that term in conformity with the purposes of article XVI, section 67(a)(3). We will thus consider the purpose of the provision, its historical context, and the collective intent of the framers andthe people who adopted it. Die&, 940 S.W.2d at 89. One aspect ofthe historical context of article XVI, section 67, is the body of law defining securities that existed in 1975. The subject of securities is comprehensively governed by legislation, so that definitions in statutes may reasonably have shaped the legislature’s understanding ofthe term “securities” in the constitutional amendment. Although we will examine statutes in effect in 1975because they are part of the historical context of article XVI, section 67(a)(3), we believe we arenot limited to the 1975versions ofthose statutes but may look at their amended and successor versions. The legislature could have adopted
a statute in 1975, or any time thereafter, defining “securities” for purposes of article XVI, section 67(a)(3), in terms of characteristics typical of that class of investment, and the definition could encompass securities with those characteristics that became available after 1975. Because the legislature has in factnot adopted astatute defining “securities,” within article XVI, section 67(a)(3),
we will examine statutes adopted for other purposes that define “securities” or address the investment of public funds in securities.
1. Securities regulatorv statutes
When this office was first asked to determine whether a particular investment was a

“security” within article XVI, section 67(a)(3), itin fact looked to a statutory definition of “security” to construe the constitutional provision. In 1980, TRS asked this office whether ithad authority toMr. Charles L. Dunlap - Page 11 (X-0043)

invest in real estate or mortgage certificates secured by real estate, and Attorney General Opinion MW-152, issued in response to this question, determined that TRS had authority to invest in mortgage certificates secured by realproperty but not in real estate itself. Attorney General Opinion MW-152 reviewed definitions of“security” found in the Securities Act, TEX.F&v. CIV.STAT.ANN. art. 581-4(A) (Vernon Supp. 1999), and in state and federal cases. It in effect determined that real estate was not a security under any definition of the term.

In 1994,the ERS asked this office whether ithad authority under article XVI, section 67 of the Texas Constitution and its enabling legislation to invest its funds in equity swap contracts and interest rate swap contracts. Attorney General Letter Opinion No. 94-052, issued in response tothis question, relied onthe definitionof‘security” or“securities”in article 581-4(A) ofthe Revised Civil Statutes, as well as the substantially similar definition of “security” in the federal Securities Act of 1933, 15U.S.C.A. 9 77b(a)(l) (West 1997), and the federal Securities Exchange Act of 1934, id. 5 78c(a)(lO). It concluded that the ERS might invest its funds in equity swap contracts or interest rate swap contracts if the contracts are securities under either federal or state securities laws, providing, ofcourse, that the ERS Board had determined that investing funds in such contracts was aprudent investment.

Your request for advice has caused us to reconsider the reasoning of Attorney General Opinion MW-152 and Letter Opinion No. 94-052. We reject their conclusion that the securities regulatory statutes are an appropriate source of the definition of “securities” within article XVI, section 67. We do, however, accept the premise of Attorney General Opinion MW-152 that a statutory definition of “securities” that predated the adoption of article XVI, section 67, may assist
us in construing the constitutional language. Attorney General Opinion MW- 152and Letter Opinion No. 94-052 relied on the definition of “securities” in the regulatory statutes without considering whether it carried out the intent of article XVI, section 67-to safeguard the funds and maximize returns to provide security for teachers. The regulatory statutes serve avery different purpose. Securities regulatory statutes were adopted to “eliminate serious abuses in a largely unregulated securities market.” Reves v.Ernst & Young,494U.S. 56,60-61(1990); UnitedHow. Found.,Znc., v.Forman, U.S. 837,849 (1975); Kadane Y.Clark, 143S.W.2d 197,199 (Tex. 1940). They define the term “securities” expansively, to help achieve the goal of protecting investors. Reves, 494 U.S. at 60-61. With certain omissions not relevant here, article 581-4 of the Revised Civil Statutes defines “security” or “securities” to include

any limited partner interest in a limited partnership, share, stock,

treasury stock, stock certificate under a voting trust agreement, collateral trust certificate, equipment trust certificate, preorganization certificate or receipt, subscription orreorganization certificate, note, bond, debenture, mortgage certificate or other evidence ofMr. Charles L. Dunlap - Page 12 (JC-0043)

indebtedness, any form of commercial paper, certificate in or under
a profit sharing or participation agreement, certificate or any instrument representing any interest in or under an oil, gas ormining lease, fee or title, or any certificate or instrument representing or secured by an interest in any or all of the capital, property, assets, profits or earnings ofany company, investment contract, orany other instrument commonly known as asecurity, whether similar to those herein referred to or not.
TEX.REV.CIV.STAT.

ANN.art. 581-4 (Vernon Supp. 1999) (emphasis added). This definition is substantially similar to the definition of “security” in the federal Securities Act of 1933,15 U.S.C. 5 77b (West 1997), and the federal Securities Exchange Act of 1934, id. fj78c(a)(lO), which also include the sweeping description “any. instrument commonly known as a ‘security,“’ in their definitions of security. Id. $5 77b(a)(l), 78c(a)(lO). In Reves v.Ernst & Young,the United States Supreme Court discussed the reasons for a definition of this breadth:

The fundamental purpose undergirding the Securities Acts is

“to eliminate serious abuses in a largely unregulated securities market.” UnitedHousingFoundation, Inc. v.Foeman, 421U.S. 837, 849, 95 S.Ct. 2051, 2059, 44 L.Ed.2d 621 (1975). In defining the scope ofthe market that itwished to regulate, Congress painted with
a broad brush. It recognized the virtually limitless scope of human ingenuity, especially in the creation of “countless and variable schemes devised by those who seek the use ofthe money ofothers on the promise ofprofits,” SEC v. WJ. Howey Co., 328 U.S. 293,299, 66 S.Ct. 1100, 1103,90 L.Ed. 1244 (1946), and determined that the best way to achieve its goal of protecting investors was “to define

‘the term “security” in sufficiently broad and general terms so as to include within that definition the many types of instruments that in
our commercial world fall within the ordinary concept ofasecurity.“’ Foeman, supra, 421 U.S., at 847-848, 95 S.Ct., at 2058-2059 (quoting H.R.Rep. No. 85, 73d Cong., 1st Sess., 11 (1933)). Congress therefore did not attempt precisely to cabin the scope ofthe Securities Acts. Rather, it enacted a definition of “security” sujkiently broad to encompass virtually any instrument that might be sold as an investment.
494 U.S. at 60-61 (footnote omitted) (emphasis added).

We have reconsidered the assumption in Attorney General Opinion MW-152 and Letter Opinion No. 94-052 that we may rely upon the definition of “securities” in the regulatory acts toMr. Charles L. Dunlap - Page 13 (JC-0043)

define “securities” in article XVI, section 67 of the Texas Constitution and have concluded that it is incorrect. Accordingly, the Board may not rely on the definition of “securities” from the Securities Act, TEX.REV.CIV.STAT. ANN.art. 581-4(A)(Vernon Supp. 1999),the federal Securities Act of 1933,15 U.S.C.A. 877b(a)(l) (West 1997),andthe federal Securities Exchange Act of 1934, id. 5 78c(a)(lO), to determine the scope of TRS’ constitutional and statutory investment authority. We overrule Attorney General Opinion MW-152 and Letter Opinion No. 94-052 to the extent they rely on the definition of “securities” in the regulatory statute to define that term for purposes of article XVI, section 67(a)(3).
2. Public Funds Investment Act

Weturn to other statutory sources ofinfonnation about theterm “securities” asused inarticle XVI, section 67. A 1967 statute authorized state boards and agencies with investment authority

to invest and reinvest any of their funds in direct obligations of or obligations the principal and interest of which are guaranteed by the United States of America; in direct obligations of or participation certificates guaranteed by the Federal Intermediate Credit Bank, Federal Land Banks, Federal National Mortgage Association, Federal Home Loan Banks, and Banks for Cooperatives; in certificates of deposit ofany bank ortrust company the kind hereinabove specified; in any other securities made eligible for such investment by other laws and constitutional provisions.

Act ofMay 25, 1967,6Oth Leg., R.S., ch. 401,1967 Tex. Gen. Laws 915 (initially codified at TEX. REV. CIV. STAT.ANN.art. 6252-5a, § 1(1925)). This provision was codified as section 2256.101 ofthe Government Code in 1995 without substantive change, Act of May 4,1993,73d Leg., R.S., ch. 268, 5 1, 1993 Tex. Gen. Laws 583, 867 (nonsubstantive revision of statutes relating to certain
areas of government, including fiscal affairs). It was repealed in 1995 by legislation amending the Public Funds Investment Act, TEX. GOV’TCODEANN.ch. 2256 (Vernon 1999). Act of May 18, 1995,74th Leg., R.S., ch. 402, $ 1, 1995 Tex. Gen. Laws 2958,2969.

The Public Funds Investment Act, chapter 2256 of the Government Code, sets out the investments in which a state agency, a local government, or a nonprofit corporation or investment pool acting on behalf of alocal government or state agency may generally invest its funds. SeeTEX. GOV’T CODEANN.$2256.003 (Vernon 1999); see also id. 5 2256.004 (provisions do not apply to public retirement system, state funds invested under section 404.024, certain higher education institutions, registry funds, and deferred qualifying compensation plans). While Government Code chapter 2256 is not a successor of the 1969 legislation, it authorizes investment of public funds in the instruments identified in the 1969 legislation as well as certain more up-to-date instrumentsMr.CharlesL.Dunlap - Page 14 (JC-0043)

suitable for such investments. Thus, its expanded list ofinvestments can be regarded as illustrative of “securities” for purposes of investing public funds.

The authorized investments generally consist ofthe following: (1)obligations of, orbacked by, the United States or its instrumentalities or a state or its political subdivisions, but excluding certain collateralized mortgage obligations, id. 52256.009; (2) secured or guaranteed certificates of deposit issued by state or national banks, savings banks or state or federal credit unions, id. 3 2256.010; (3) fully-collateralized, repurchase agreements or reverse repurchase agreement with certain terms and attributes, id. $2256.011; (4)banker’s acceptances, again with certain terms and attributes, id. 5 2256.012; (5) high-grade commercial paper, id. 5 2256.013; (6) no-load money market mutual funds or no-load mutual funds with specific attributes, id.9 2256.014; (7) secured, guaranteed investment contracts, id 52256.015; and (8) cash management funds sponsored by taxexempt organizations, high-grade, negotiable certificates of deposit, and high-grade corporate obligations, id. 52256.020.

The Public Funds Investment Act deals with the investment ofpublic moneys and represents
alegislative balancing ofmaximizing investment flexibility andprotecting public funds inthe choice of the authorized investments listed. The purposes and interests served by this statute are closer to those underlying article XVI, section 67(a)(3) than those served by the regulatory statutes, but they
arenot identical. For example, the TRS funds arenot public moneys but trust fund moneys invested toprovideretirement benefits forteachers. SeeTex. Att’y Gen. Op.Nos. JM-300 (1985) (retirement fund ofERS is atrust fund), WW-565 (1959) (ERS assets aretrust funds.). But more importantly, the Public Funds Investment Act does not define the term “securities.” While its categorical listing of authorized investments may include examples of securities, it does not assist the TRS Board to determine whether or not other investments may be securities. Accordingly, we cannot rely on the Public Funds Investment Act to define securities for the purposes of the constitutional provision.

3. Article 717m-1, TEX.REV.Crv.STAT. ANN.,validation of securities

We next consider article 717m-1 ofthe Revised Civil Statutes. The statute was adopted in 1979, Act of May 27, 1979, 66th Leg., R.S., ch. 400, 1979 Tex. Gen. Laws 874, repealing and replacing a similar provision dating from 1959. SeeAct ofMay 6, 1959, 56th Leg., R.S., ch. 316, 5 1,1959Tex. Gen. Laws690 (codified asarticle717m, TEX.REV.CIV.STAT.ANN. (1925)). Article 717m-1 authorizes any state or local governmental entity to institute an in rem proceeding for a declaratory judgment on its authority to issue securities and asto the legality orvalidity of anyMr. Charles L. Dunlap - Page 15 (JC-0043)

proceedings relating to the securities. See TEX. REV. CIV. STAT. ANN.art. 717m-1, $4 l(l), 2 (Vernon Supp. 1999). In contrast to the Public Funds Investment Act, article 717m-1 defines the term securities:

“Securities”means all interest-bearing obligations, including without

limitation, any bonds, notes, bond anticipation notes, warrants, certificates, or other evidences of indebtedness, whether general or special, whether negotiable or nonnegotiable in form, whether in bearer or registered form, whether in temporary or permanent form, whether with, or without interest coupons, and regardless of the
source of payment, whether t?om taxes, revenues, or both, or otherwise.
Id. $ l(2). See TEX. REV. CIV. STAT. ANN art. 717m (1925) (repealed) (“securities” in the predecessor statute, consisted of “bonds, notes, or other evidences ofindebtedness whether payable from taxes, revenues, orboth taxes andrevenues”). But the purpose ofarticle 717m-1 is completely different Tom that of article XVI, section 67. Article 717m-1 allows governmental bodies to obtain declaratory judgments asto governmental securities. Although securities isdefined broadly interms of “evidences ofindebtedness,” itisnonetheless limited togovernmental securities, consistent with that statute’s purpose and intent. See Hatten v. City ofHouston, 373 S.W.2d 525, 534 (Tex. Civ. App.-Houston 1963,writref dn.r.e.) (article 717m, TEX. REV. CIV. STAT.ANN. (1925), was adopted to provide speedier and more efficient method of adjudicating validity of public securities than previously available). The purpose ofarticle 717m-1differs greatly from that ofTexas Constitution, article XVI, section 67(a)(3), and its narrow definition of “securities” is not relevant to the investment purposes of the constitutional provision. While article 717m-1 identities a class of securities in which the TRS may invest, its definition of “securities” does not illuminate that term
as it appears in the constitutional provision we address.
4. Uniform Commercial Code definition of securities

We turn to the standard and most commonly accepted definition of investment securities under Texas law, namely that in chapter 8 of the Business and Commerce Code, Uniform Commercial Cod+Investment Securities. See TEX. Bus. & COM. CODE ANN.5 8.102 (Vernon Supp. 1999) (defining securities). The legislature adopted the Uniform Commercial Code in 1965 and revised and reenacted it in 1967aspart ofthe Texas Business and Commerce Code.’ Therefore, the legislature was aware of this statute and its definition of securities when it proposed the 1975 constitutional amendment authorizing the TRS toinvest theretirement funds in securities. SeeAcker

‘SeeAct ofMay 19, 1965,59thLeg.,R.S., ch. 721,196S Tex. Gen. Laws 1, 132(UniformCommercialCode), repealed

by Act of May 25, 1967, 60th Leg., RX, ch. 785, $1, 1967 Tex. Gen. Laws 2343, 2498 (revising and reenacting Uniform Commercial Code aspart of Texas Business and Commerce Code).Mr. Charles L. Dunlap - Page 16 (JC-0043)

v. Texas Water Comm ‘n,790 S.W.2d 299,301 (Tex. 1990); Garner v.Lumberton Indep. Sch.Dist., 430 S.W.2d 418,423 (Tex. Civ. App.-Austin, no writ) (statute ispresumed to have been enacted by legislature with complete knowledge ofexisting laws,particularly those dealing with subject matter under consideration). Section 8.102(a)(l5) ofthe Business and Commerce Code setsout the general definition of a security in terms of the attributes that an instrument must possess to qualify as a security:

“Security,” except asotherwise provided in Section 8.103, means an

obligation ofan issue? or ashare, participation, or other interest in an issuer or in property or an enterprise of an issuer:
(A) that is represented by a security certificate in bearer or registered form,3orthe transfer ofwhich may be registered onbooks maintained for that purpose by or on behalf of the issuer;
(B) that is one ofaclass or series orby its terms isdivisible into
a class or series shares, participations, interests, or obligations; and
(C) that: (i) is, or is of a type, dealt in or traded on securities exchanges or security markets; or (ii) is a medium for investment and by its terms expressly provides that it is a security governed by this chapter.

See TEX.Bus. & COM.CODE ANN.5 8.102(U) (Vemon Supp. 1999) (footnotes added). In short,
a security is a share or participation in an enterprise or an obligations that (1) is fully transferable, (2) is one of a series rather than an individual contractual obligation, and (3) is itself or is of atype

““Issuer” generally includes a person (1) that places OIauthorizes the placement of its name to evidence an interest initsproperty or enterprise or duty toperform anobligation represented by the certificate, (2) creates an interest in itsproperty or inan enterprise orundertakes an obligation, that isanuncatiticated security, (3) directly or indirectly creates a fractional interest in its rights or property, ifthe fractional interest is. represented by a security certificate, OI (4) becomes responsible for or inplace of another person described asan issuer. TEX.BUS.&COM. CODE ANN.5 8.201 (Vernon Supp. 1999). A “certificated security” simply means a security that is represented by a certificate, id. 5 8.102(a)(4), and an “uncertificated security” is a security not represented by a certificate, id. 5 8.102(a)(18).

‘“Bearer form” applies to acertificated security andmeans aform inwhich the security ispayable to thebearer of the security certificate according to itsterms and not by reason of any indorsement. Id. 5 8.102(a)(2). “Registered form” also applies to acertificated security andmeans aform inwhich the security certificate names the person entitled topayment; and a transfer ofthe security may be registered on books maintained by the issuer for thatpurpose “or the security so states.” Id. g 8.102(@(13).Mr. Charles L. Dunlap - Page 17 (JC-0043)

of interest dealt in or traded on securities market or exchanges, or is a medium of investment and, by its terms, a security governed by chapter 8 (“opt-in provision”). See id. 5 8.102 cmt. 15.
Section 8.103 ofthe Business and Commerce Code further elaborates andrefines the general definition in section 8.102(a)(l5) by providing that:

(a) A share or similar equity interest issued by a corporation, business trust,joint stock company, or similar entity is a security.
(b) An investment company security is a security. “Investment company security” means a share or similar equity interest issued by
an entity that is registered as an investment company under the federal investment company laws, an interest in a unit investment trust that is so registered, or a face-amount certificate issued by a face-amount certificate company that is so registered. “Investment company security” does not include an insurance policy or endowment policy or annuity contract issued by an insurance company. (c) An interest in apartnership orlimited partnership company is not a security unless it is dealt ortraded on securities exchanges or in securities markets, its terms expressly provides that it is a security governed by this chapter, or it is an investment company security. However, an interest in apartnership or limited liability company is
a financial asset4ifit is held in a securities account.

. (e) An option or similar obligation issued by a clearinghouse corporation to itsparticipants isnot asecurity, but isafinancial asset. (f) A commodity contract, as defined in Section 9.115, is not a security or a financial asset.
Id. 8 8.103 (footnote added). Section 8.103 supplements the general definitions of security and is

“intended to foreclose interpretive issues concerning the application of the general definitions to several specific investment products.” Id. 5 8.103 cmt. 1. Thus, subsection (a) establishes that ordinary corporate stock is a security irrespective of whether it is dealt with or traded on the

“‘Financial asset” is a broader category of obligations, shares, participation, and interest that includes

“securities,” to which assets other UCC rules may apply. See id. 5 8,102(a)(9) & ant. 9.Mr. Charles L. Dunlap - Page 18 (JC-0043)

securities exchange or in the securities market. Id. cmt. 2. Accordingly, shares of a closely held corporation constitute securities. Id.; Kenney v. Porter, 604 S.W.2d 297, 302 (Tex. Civ. App.Corpus Christi 1980, writ ref d n.r.e.) (stating that it is generally recognized that stock of closely held corporation is a security). Additionally, investment vehicles offered to the public by investment companies registered under the federal Investment Company Act of 1940 are securities under subsection (b),notwithstanding that the “typical transaction in shares ofopen-end investment companies is an issuance orredemption, rather than atransfer of shares horn one person to another”
as in the ordinary corporate stock transaction. TEX.BUS.& COM.CODE ANN.$ 8.103(b) cmt. 3 (Vernon Supp. 1999). Subsection (c) is intended to clarify the application “of the type” language in section 8.102(a)(l5)(iii) topartnership interests and establishes the general rule that apartnership
or limited partnership interest is not a security unless it is commonly dealt in or traded on the financial markets, it has an explicit opt-in provision, or it is an investment company security. Id. cmt. 4. Seegenerally Andrea G.Nadel, J.D., Annotation, What isa Security Under UCCArt. 8,11 A.L.R. 4th 1036, 5 11 (Supp. 1998) (discussing cases generally holding partnership interest not securities). Finally, subsections (e) and (l) make clear that trade-stock options or commodity contracts are not securities. Id. cmt. 6; see generally 11 A.L.R. 4th 1036 (1982 & Supp. 1998) (discussing generally instruments found by courts to constitute “securities” under UCC chapter 8).

In sum, chapter 8 of the Business and Commerce Code provides a functional and flexible definition of securities (the “UCC definition”). TEX.Bus. & COM.CODE ANN.$ 8.102 cmt. 15 (Vernon Supp. 1999); id. $ 8.103 cmt. 1;Kenney, 604 S.W.2d at 301 (definition and comments explain parameters of what instruments qualify as security). Given that the UCC definition generally requires that securities beinstruments commonly dealt inortraded on the securities market
or exchange-the common understanding ofthe term “securities’‘-we believe that this definition is more likely to express the intent ofthe legislature and the people in adopting article XVI, section 67, than the more amorphous definitions found in regulatory statutes and dictionaries.

We note that theunderlying purpose ofchapter 8isdifferent from that ofarticle XVI, section 67. The underlying purpose ofthe constitutional provision isto safeguard the funds and maximize returns toprovide security forteachers. Chapter 8,on the other hand, isdesigned to define the rights and duties associated with investments that qualify as securities and to state the rules relating to the transfer and establishment of those rights and duties. TEX.BUS.& COM. CODE ANN.5 8.101 cmt. (Vernon Supp. 1999). Nevertheless, because chapter 8addresses investment securities, its purpose ismore compatible with that ofthe TRS constitutional provision than the federal and state securities regulatory statutes. The UCC definition ismore fixed and certain. See id$5 8.102(a)( 15), ,103; see also Thomas Y.Creager, 107 S.W.2d at 710 (favoring construction ofconstitutional provision that will cause fewer or less complicated questions in its application). Generally, its purpose is to encompass instruments commonly accepted as securities. TEX. Bus. & COM. CODEANN. $5 8.102(a)(l5), ,103 (Vernon Supp. 1999). As a result, although fewer investments qualify as securities under the UCC definition than under the regulatory definitions, amore restricted class ofMr. Charles L. Dunlap - Page 19 (JC-0043)

investments comports more with the constitutional purpose of defining a universe of securities in which moneys to provide teachers’ retirement benefits may be safely and profitably invested.

But while more restrictive in some ways than the regulatory statutes’ definitions, the UCC definition is not categorical. Unlike former article III, section 48b of the Texas Constitution, the Public Funds Investment Act, or article 717m-1 of the Revised Civil Statutes, it does not set forth
an exclusive list of investment categories. Instead, it defines “securities” according to certain attributes that allow incorporation of anew investment product that becomes generally accepted as amedium of investment in the financial markets, as long as the instrument otherwise conforms to the statutory requirements. SeeTEXBUS. &COM.CODE

ANN.58.102 cmt. 15(vemon Supp. 1999) (explaining first two components of section 8.102(a)(l5) test that must be satisfied and noting that third requirement, the “functional test,” provides flexibility “while ensuring that the Article 8 rules do not apply to interests or obligations in circumstances so unconnected with the securities markets

.“).
Moreover, the UCC definition provides more guidance than the other definitions we have considered. Sections 8.102(a)( 15)and 8.103 andthe official comments tothese sections explain the parameters of the class of instruments qualifying as securities. See id. fj$ 8.102, ,103 & cmts. Accordingly, the more concrete UCC definition provides a better framework for determining whether aparticular instrument is a security than definitions phrased in general, descriptive terms, such asnotes, bonds, debentures, and similar terms. SeeKenney, 604 S.W.2d at 301 (definition and comments explain parameters of the instruments qualifying as securities).

While not aperfect tit, webelieve the UCC definition of security is abetter fitthan any other definition of which we are aware. We believe the UCC definition generally comprises the instruments commonly understood to constitute securities and asaresult represents abetter balance of investment flexibility and fiscal restraint. Additionally, it also provides a more functional criterion for determining whether particular instruments aresecurities. Moreover, this definition was in place when the legislature proposed adoption of the TRS constitutional provision, and it is reasonable to assume that the legislature understood the term “securities” to be defined as it is in chapter 8 of the UCC. Accordingly, we advise you that the term “securities” as used in Texas Constitution article XVI, section 67, is to be defined according to the UCC definition, until the legislature adopts adefinition pursuant tothe constitutional provision oruntil itisjudicially defined.Mr. Charles L. Dunlap - Page 20 (JC-0043)

III. TRS authoritv under the UCC definition

In questions two and three, you ask whether specific kinds of instruments are securities in which the TRS trust fund may be invested:

2. Will an investment in “alternative,” real estate-related, or other asset classes having similar investment attributes constitute a security in which TRS may invest if it is an instrument or vehicle listed, defined, or specified
as a “security” either in The Securities Act, or in a federal securities law, or in the securities law of another state, or by the Securities and Exchange Commission?

3. Do any of the following vehicles or investments constitute “securities” which are listed, defined, or specified as a “security” in The Securities Act and therefore require no further “security” analysis by TRS: a limited partnership, alimited liability partnership (LLP), alimited liability company (LLC), areal estate investment trust @BIT), areal estate operating company (REOC), a group trust or commingled fund,joint ventures, financial futures,
or investment accounts? If so, please identify which vehicles or investment categories constitute securities.

We have determined that “securities” within article XVI, section 67(a)(3) isto be defined in according to the definition ofthat term in the Uniform Commercial Code, while your questions are framed in light of prior opinions defining “securities” according to the state and federal regulatory statutes. In answer to questions two and three, we advise you that the TRStrust fundmay beinvested ininstruments defined assecurities by sections 8.102(a)(l5) and 8.103 oftheBusiness andcommerce Code. The attributes of aparticular investment aremore important than the name ofthe category to which the investment belongs. Although you name certain types of enterprises or investments, you do not provide information about their attributes that would allow us to determine even generally whether they constitute securities under sections 8102(a)(l5) and 8.103. For example, even the provision excluding limited partnerships as a general matter from the definition of “securities” has exceptions. See TEX. BUS. & COM. CODEANN. 5 8.103(c) (Vernon Supp. 1999) (partnership or limited partnership interest is not a security unless it is commonly dealt in or traded on the financial markets, it has an explicit opt-in provision, or it is an investment company security). Because the definition of “securities” from chapter 8ofthe Business and Commerce Code provides much greater clarity than the definition from the regulatory statutes, we believe that the TRS itself will be able to answer many of its questions about particular investments. If questions remain about specific investments, the TRS Board may of course seek advice from this office.Mr. Charles L. Dunlap - Page 21 (K-0043)

Your fourth and fifth questions are as follows:

4. If your answer to #2 or #3 above is negative in any respect or in
cases where the task is to analyze and determine whether an investment instrument orvehicle isasecurity under Texas law,will an investment in “alternative,” real estate-related, or other asset classes having similar investment attributes constitute asecurity inwhich TRS may invest if it is an instrument or vehicle which meets the requirements of an investment contract under the “Howey test,” as applied by Texas courts? See S.E.C.v. W.J.Howq Co.,328U.S. 293, 66 S.Ct. 1100,90 L.Ed. 1244(1946) anditsprogeny, including federal and Texas cases. If any vehicle or investment category listed in #3 is not identified by you as a “security,” will or may such a vehicle or investment category qualify as a security under the Howey test?

5. What criteria are available to assist TRS in determining the level of participation or the control features TRS may have asreflected in the negotiated provisions of the investment documents, e.g. the investment contract documents or the limited partnership agreement, without jeopardizing the “security” designation of a particular investment.

Given that webelieve that theUCC definition of “securities” informs the meaning ofthatterm in article XVI, section 67, the “Howey test” is inapposite. That test developed under the securities regulatory statutes, which we believe are at cross-purposes with the constitutional authorization in article XVI, section 67(a)(3). Accordingly, TRS should rely on the more certain yet flexible UCC definition.

We also wish topoint out that, despite our overruling ofAttorney General Opinion MW-152, real estate itself is not a “security” for purposes of article XVI, section 67(a)(3) of the Texas Constitution, because it is not included in the definition of “securities” found in chapter 8 of the Business and Commerce Code asdiscussed above. SeeTEX. Bus. &COM.

CODE ANN.58.102(a)( 15) (Vernon Supp. 1999) (“security” is a share orparticipation in enterprise, that is fully transferable and is one of a series rather than an individual contract). Moreover, Attorney General Opinion MW-152 concluded that, “[i]n view ofthe long established and dominant legislative andjudicial construction that realty is not within the ambit of “securities, ” it is our opinion that constitutional amendment would be necessary to enable the board of trustees of the Teacher Retirement System to invest its funds in realproperty.” Our decision about the definition ofsecurity has not changed this conclusion.Mr. Charles L. Dunlap - Page 22 (JC-0043)

IV. Delegation ofinvestment authority

Your remaining question concerns whether the Board may delegate authority to manage certain investments to outside persons:

6. May TRS use its authority under 5 825301(b) of the Texas Government Code to allocate responsibilities to outside managers in the management of “alternative” or real estate-related securities? See TEX. GOV’T CODE ANN. 5 825.301(b) (Vernon 1994). By “outside manager,” we understand you to mean “external manager.” An “external manager” is “[a] person or firm that makes investment portfolio decisions and executes transactions independently, subject to the overall restrictions agreed upon by contract between the fiduciary for the fund and the external manager.” Review supra, at 179. An external manager’s role differs from that of an “investment advisor,” who is retained by an investing entity to provide investment advice for a fee. Id. at 180. An investment advisor may, for example, present information about the economic climate in general or industry information that may affect the entity’s decisions about investing in specific securities. Id.

The report prepared by Independent Fiduciary Services, Inc. discusses the merits of internal
versus external investment management ofTRS timds andrecommends thatthe Board “seek to obtain appropriate clarification or support (whether through legislation, constitutional amendment, if necessary or otherwise), permitting itto delegate investment authority.” IFS Report supra, at 7,14, 16, 54. Accordingly, you ask whether section 825.301(b) authorizes TRS to delegate to private persons or firms the authority to make investments on its behalf, subject to restrictions agreed upon by TRS and the private person or firm.

Section 825.301(b) ofthe Government Code provides asfollows: “The board oftrustees may contract with private professional investment managers to assist the board in investing the assets of the retirement system.” TEX.GOV’T CODE ANN.5 825.301(b) (Vernon 1994).

In Attorney General Letter Opinion No. 92-37 this office construed a similar provision applicable to the trustees ofcertain municipal fire tighter retirement systems. Section 28(a) ofarticle 6243e ofthe Revised Civil Statutes formerly authorized theboard oftrustees to “employ professional investment counselors to assist and advise the board in the investment of the assets of thefund.” (Emphasis added). Act ofApr. 27,1989,71st Leg., R.S., ch. 98, § I,1989 Tex. Gen. Laws 426,436, amended byAct ofMay 7,1993,73d Leg., R.S., ch. 173,s 12,1993 Tex. Gen. Laws 326,328. This office concluded that subsection 28(a) “clearly does not permit the board of trustees to delegate its entire discretionary authority over investments to aprofessional investment counselor,” and that the phrase “assist and advise” circumscribed the duties of any investment counselor selected by theMr. Charles L. Dunlap - Page 23 (JC-0043)

Board, “to the extent that the board will retain all final decision-making with regard to investments.”

In our opinion, Attorney General Letter Opinion No. 92-37 correctly interpreted the phrase

“assist and advise.” Under article 825.301(b), the TRS Board may seek advice horn outside investment counselors to assist it in making its investment decisions, but the Board must retain final decision-making asto all investments andmay not delegate to outside investment managers thepower to decide which securities to purchase with assets of the retirement fund.

A comparison of article 825.301(b) with provisions expressly authorizing such delegations supports our construction of article 825.301(b). Section 28 of article 6243e of the Revised Civil Statutes, the statute on municipal fire fighter retirement systems that Attorney General Letter Opinion No. 92-37 construed, has been amended to read as follows:

(a) The board oftrustees. may appoint investment managers for the system by contracting for professional investment management services with one ormore organizations, which may include abank if it has a trust department, that are in the business of managing investments.

. . . (c) In a contract made under this section, the board of trustees shall specify policies, requirements, and restrictions that the board of trustees adopts for investments of the system. (d) [board must act prudently in choosing and contracting for professional investment management services]

. (e) A trustee is not liable for the acts or omissions of an investment manager appointed under this section, nor is a trustee obligated to invest or otherwise manage any asset of the system subject to management by the investment manager. (f) A board of trustees may employprofessional investment counselors to assist and advise the board in the investment of the assets of thefund or to evaluate the performance of an investment manager appointed under this section.

Act ofMay 7,1993,73d Leg., R.S., ch. 173,s 12,1993 Tex. Gen. Laws 326,328 (emphasis added).Mr. Charles L. Dunlap - Page 24 (JC-0043)

The amended version of article 6243e, section 28 adds significant new authority to aboard’s existing power toreceive advice fromprofessional investment counselors. Aboard may now contract with an organization, including abank with atrust department, to manage and invest the assets ofthe system. See TEX.REV.CIV.STAT. ANN.art. 6243e, $28(a), (e) (Vernon Supp. 1999). Ifthe board decides to continue to invest some or all of the assets of the fimd, it retains authority under section 28(f) to seek assistance and advice from aprofessional investment counselor. The Board ofTRS, in contrast, has only the authority to contract for advice and assistance concerning its investment decisions. Nothing in section 825.301(b) allows the TRS Board to delegate investment authority to outside managers that section 28 of article 6243e ofthe Revised Civil Statutes gives to the boards of municipal fire tighter retirement systems.
Article XVI, section 70 ofthe Texas Constitution, which established the Texas Growth Fund under a board of trustees, states that the board of trustees shall manage the investment of the fund, and may “employ andretain staff, including achief executive officer; set investment policy ofthe fund; .[and] adopt rules regarding the operation ofthe fund.” “[Alltematively, or in combination with its own staff,” the board may “contract for the management of investments under this section with aprivate investment management firm

.” Because our conclusion rests on statutory grounds,
weneed not, and donot, decide the significance, ifany, ofthese differences in constitutional wording.

Because we have determined that TRS lacks statutory authority under Government Code section 825.301(b) to delegate investment authority to outside managers, we do not decide whether article XVI, section 67(a)(3), would permit such delegation by TRS of its investment authority to outside managers. As we have already noted, however, article XVI, section 67(c) places fewer constraints on local benefit systems, such as systems benetitting local firefighters, than article XVI, section 67(a)(3) places on statewide retirement systems such asTRS. Further, we note the existence of constitutional authority related to the Texas Growth Fund that provides more explicitly for delegation.

Our reading of the statutory authority of the TRS Board of Trustees is consistent with case law on the delegation ofatrustee’s authority. Generally, atrustee may not delegate his discretionary power to another; however, atrustee, after determining how to exercise his discretion, may authorize another to carry out ministerial or mechanical acts to effectuate such decision. Trunsamerican Leasing Co. v. Three Bears, Inc., 586 S.W.2d 472,476 (Tex. 1979); Westv.Hapgood, 174 S.W.Zd 963 (Tex. 1943). There is an exception to the rule against atrustee’s delegation of his discretionary power to another, where the settlors give thetrustee the express power ofdelegation. Transamericun Leasing Co., 586 S.W.2d at 476. Because the Board of TRS does not have express authority to delegate its authority to invest in securities to private firms, the exception does not apply. Accordingly, the trustees of TRS may not allocate to private investment managers their power to decide to invest the TRS fund in particular securities.Mr. Charles L. Dunlap - Page 25 (JC-0043)

SUMMARY

The Board ofTrustees ofthe Teacher Retirement System ofTexas (“TRS”) has authority under article XVI, section 67(a)(3) ofthe Texas Constitution to invest the funds of the retirement system “in such securities as the board may consider prudent investments.” TEX. CONST.art. XVI, 5 67(a)(3). In the absence of legislation defining

“securities” within this provision, this term isdefined asthe authorized investments set out in chapter 8ofthe Texas Business and Commerce Code. The conclusions ofAttorney General Opinion MW-152 (1980) and Letter OpinionNo. 94-052, that “securities” for purposes ofTRS investment is defined by the state and federal securities regulatory statutes, areoverruled. However, Attorney General Opinion MW- 152 correctly determined that real property is not a security within article XVI, section 67(a)(3) of the Texas Constitution.

The Board of Trustees may seek advice from outside investment counselors to assist it in making its investment decisions; the Boardmay not, however, delegate to external investment managers its authority to decide in which securities the TRS fund is to be invested.

Attorney General ofTexas

ANDY TAYLOR First Assistant Attorney General

CLARK RENT ERVIN Deputy Attorney General - General Counsel

ELIZABETH ROBINSON Chair, Opinion Committee Prepared by Susan L. Garrison Assistant Attorney General