DAN MORALES 

.Al-rORNEY GENERAL 

QBffice of tip !&tornep @heral 

d&ate of Qexag 

Honorable O.H. “Ike” Harris 

Chair 

Committee on State AtEtim 

Texas State Senate 

P.O. Box 12068 

Austin, Texas 78711 

December 10.1993 

Opinion No. DM-274 

Re: Whether, in accordance with section 2 

of the Public Funds Investment Act, 

V.T.C.S. article 842a-2, a public funds 

investment pool may “purchase. se& or 

invest its funds or funds under its control” in 

wvered call contracts or covered put 

camacts (RQ-605) 

Dear Senator Harris: 

You have asked us to consider whether, under section 2 of the Public Funds 

Investment Act (the “act”), V.T.C.S. article 842a-2, a public timds investment pool may 

purchase and sell United States government securities through the writing of covered cab 

contracts or covered put contrackt We determine that it may not. 

Section 791.011(a) of the Government Code authorizes a local government to 

contract with another local government to perform certain governmental finctions and 

services. For purposes of the Interlocal Cooperation Act, see Goti Code 5 791.002, 

“Sovemmentrd fbnctions and services” includes public funds investment. Id. 

5 791.003(3)(L). The act limits the investment authority of several political subdivisions, 

inchiding a public timds investment pool2 created under chapter 791 of the Government 

Code. See also Tex. Const. art. III, $52(e) (providing that county, city, town, or other 

political corporation or subdivision may invest its funds as authorized by law). 

Section 2(a) of the act provides in pertinent part that 

any. . public funds investment pool created under Chapter 791, 

Government Code, acting on behalf of [an incorporated city or town, 

a county, a, public school district, a district or authority created under 

Article III, Section 52@)(l) or (2) or Article XVI, Section 59 of the 

‘For a description ofmvad call contracts and covered put mntracts. see in/hap 5. 

%mtion Z(c)(4) of the act de&es “public tbds investment pool” as “an entity aWed to invest 

plblic funds jointly on behalf of the entities that participate in the pool and whose investment cbjectivcs in 

order of priority arc: firs& safety of principal; semnd, liquidity; and third, inmmc.” Acts 1993,73d Leg., 

ch.!w,~1. 

p. 1431 
Honorable O.H. “Ike” Harris - Page 2 (DM-274) 

Texas Constitution, an institution of higher education as defined by 

Section 61.003 of the Education Code, a hospital district, or a fresh 

water supply district] may, in accordance with this Act, purchase, 

sell, and invest its tinds and funds under its control in : 

(I) bbhgatibns of the United States or its agencies and 

instrumentalities; 

(3) other obhgations, the principal of and interest on which are 

unconditionally guaranteed or insured by, or backed by the till faith 

and credit of, . the United States or its agencies and instrumentalities; 

. 

(9) ti.111~ collateral&d repurchase agreements having a defined 

termination date, secured by obligations described by Subdivision (1) 

of this subsection, pledged to the political entity and deposited with a 

third party selected and approved by the political entity, and placed 

through a primary government securities dealer, as defined by the 

Federal Reserve, or a bank domiciled in this state. 

Acts 1993, 73d Leg., ch. 946, 5 1, at 4055-56; see also id. at 4057 (adding 5 2(e)) 

(authorizing any entity listed in subsection (8) to invest its funds and fimds under its 

control in eligible public funds investment pool if entity’s governing body resolves to 

authorize investment in particular pool). You ask us to determine whether a public funds 

investment pool may purchase, sell, or invest its fimds in covered call contracts and 

covered put contracts. The act sptcificahy lists the types of investments that a public 

tbnds investment pool is authorized to make. The enumerated list does not expressly 

include covered call contracts and covered put contracts. See generalZy Attorney General 

Opinions JM-1210 (1990); MW-506 (1982); M-607 (1970). We must determine, 

therefore, whether any of the explicitly listed permissible investments includes covered call 

contracts and covered put contracts. In our opinion, the listed permissible investments do 

not include covered call contracts and covered put contracts. 

We believe that the only permissible investments listed in section 2(a) of the act 

that might include covered call contracts and covered put contracts are those described in 

subsection (a)(l), (3). and (9). See supra pp.]-2 (quoting V.T.C.S. art. 8428-2, 5 2(a)(l), 

(3), (9)). We will consider first whether section 2(a)(l) includes covered call contracts 

and covered put contracts, i.e., whether a covered call contract or a covered put contract 

is 8n “obhgation[] of the United States or its agencies and instrumentalities.” Attorney 

General Opinion IM-I 20 1 ( 1990) is relevant to our inquiry, 

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Honorable O.H. “Ike” Harris - Page 3 (DM-274) 

In Attorney General Opinion M-1201 this office considered whether the Veterans’ 

Land Board was authorized to enter into a call option contract. That opinion noted that 

article III, sections 49-b and 49-b-l of the Texas Constitution authorize the Veterans’ 

Land Board to invest “in bonds or obligations of the United States.” Attorney General 

Opinion JM-1201 at 2. Thus, the question this office faced was whether a c8ll option 

contract is a bond or obligation of the United States. Id. After examining the history of 

article III, sections 49-b and 49-b-l of the Texas Constitution, the opinion determined that 

the phrase “bonds or obligations of the United States” denotes credit instrumentalities of 

the federal government. Id. at 5. According to the opinion, such credit instrumentalities 

are characterized by (1) written documents, (2) the bearing of interest, (3) a binding 

promise by the United States to pay specified sums at specified dates, and (4) specific 

congressional authorization that pledges the faith and credit of the United States in 

support ofthe promise to pay. Id. (citing Smith v. Davis, 323 U.S. 111, 114-15 (1944)). 

The opinion described 8 “call option” contract as 

a promise to sell 8 security in the firtIne at a price fixed today. 

The seller agrees to deliver the security for a set price (the “strike 

pricer’) during a limited time. As described by the United States 

Court of Appeals for the Seventh Circuit: 

The buyer pays 8 sum (the “premium”) for the [call option]. 

The strike price exceeds the current market price of the 

security. Sellers are betting that the price will not exceed 

the strike price during the duration of the option; buyers are 

betting that it will. 

Board of Trade of City of Chicago v. Securities & 

Exchange Comm’n, 883 F.2d 525, 527 (7th Cir. 1989). 

Id. at 6-7. This office concluded that a call option contract does not satisfy the four 

characteristics of credit instrumentalities of the United States because such a contract 

represents an instrumentality of a third party, not of the United States. Id. at 5. “[T]he 

consideration to flow to the [Veterans’ Land Board] from [a call option contract] is merely 

a promise from a third party regarding the manner in which the third party will deal with 

credit instrumentalities of the United States. Such third parry obligations do not become 

oouptlons of the United States, merely because the arsefs which are subject of speculative 

transactions with the third party are obligations of the United States.” Id. 8t 6. 

Accordingly, the opinion concluded that an investment in a call option contract is not an 

investment in an Oblig8tiOII of the United States, and the Veterans’ Land Board therefore is 

unauthorized to enter into such transactions3 Id. 

3Yeur question appears to assume that the writing of covered call mntnrcts and mvered pat 

mntmets is simply 8 means by which a public funds investment pool may purchase or sell United States 

government obligations. Attorney General Opinion Jhl-I201 refutes that assamption. 

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Honorable O.H. “Ike” Harris - Page 4 (DM-274) 

We found no legislative history indicating that the legislature intended to include 

covered call contracts and covered put contracts within the ambit of section 2(a)(l) of the 

act, “obligations of the United States or its agencies.” Additionally, based on the similarity 

between a call option contract, as described in Attorney General Opinion Jh4-1201, and 

your description of-a covered call contract and a wvered put contract, we believe that 

neither a covered call wntract nor a covered put contract is an obligation of the United 

States or its agencies and instrumentalities. Similarly, section 2(a)(3), which authorizes 

investments in obligations that the United States or its agencies and instrumentalities 

unwnditionally guarantee, insure, or back with the full faith and credit of the United 

States, does not encompass covered call contracts and wvered put contracts. As this 

office determined in Attorney General Opinion JM-1201, a call option contract “is merely 

II promise from a third party regarding the manner in which the third party will deal with 

credit instrumentalities of the United States.” Attorney General Opinion JM-1201 8t 6. 

The United States or its agencies and instrumentalities do not guarantee, insure, or back 

the promise of the third party. 

Finally, we must consider whether covered call contracts and covered put 

contracts are repurchase agreements within the scope of section 2(a)(9) of the act. In the 

context of the act, 8 “repurchase agreement” is 

a simultaneous agreement to buy, hold for a specified time, and then 

sell back at a future date, obligations [of the United States or its 

agencies and instrumentalities], the principal and interest ofwhich are 

gwr8ntee.d by the United States or any of its agencies, in market 

value of not less than the principal amount of the funds disbursed. 

The term includes direct security repurchase agreements and reverse 

security repurchase agreements. 

V.T.C.S. art. 842a-2, $2(c)(3). 

You explain that 8 direct security repurchase agreement is a contract between a 

seller and a buyer, in which the seller agrees to sell obligations of the United States or its 

agencies and instrumentalities, then to buy them back at an agreed upon price and a 

specified date. On the other hand, a reverse security repurchase agreement is a contract 

between a dealer in government securities and an investor, in which the dealer agrees to 

r-.-Z .___ C,u:; the investor United States government securities and the investor agrees to 

repurchase the securities at a later date. This office previously has described a repurchase 

agreement as “essentially a short-term collateralized loan.” Anomey General Opinion 

JM-23 (1983) 8t 1. 

The act thus authorizes a public t%nds investment pool to purchase, sell, or invest 

its funds and funds under its control in United States government securities. You indicate 

that settlement on the outright purchase or sale of United States government securities 

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Honorable O.H. “Ike” Harris - Page 5 W-274) 

occurs within one to five business days. 4 In addition, as you note, the act expressly 

authorizes a public funds investment pool to purchase, sell, and invest its fbnds and tinds 

under its control in repurchase agreements that meet certain standards. You point out that, 

in contrast to an “outright” purchase or sale of securities, under a repurchase agreement 

@oth a direct security repurchase agreement and a reverse secu~rity repurchase 

agreement), the United States securities are delivered to the buyer at 8 date beyond the 

usual settlement time, which, as stated above, generally is five business days. 

You state that such “forward delivery” also is a characteristic of covered call 

contracts and covered put contracts. You explain such contracts as follows: 

An investor who writes a covered call receives an income 

premium, a sum of money, and agrees to sell a vnited States] 

Government security, already owned by the investor, at a future date 

and at an agreed price. The call writer is considered covered when 

the investor already owns the underlying [United States] Government 

security agreed to be sold under the covered call contract. 

On the other hand, an investor who writes a covered put 

receives an income premium, a sum of money, agrees to buy a 

[United States] Government security at a future date and at an 

agreed price. The put writer is considered covered when the investor 

has a sufficient cash reserve equal to the total purchase price agreed 

to under the covered put contract. 

Thus, under a covered call contract, an investor agrees to sell certain specified United 

States government securities in the future; under a covered put contract, an investor 

agrees to buy certain specified United States government securities in the future. Neither 

transaction includes a subsequent buy-back of the securities. In contrast, under either a 

direct security repurchase agreement or a reverse security repurchase agreement, one 

party to the transaction agrees to sell United States government securities now and to buy 

the securities back at a later specified date. 

The legislature enacted the Public Funds Investment Act in 1987 to enable certain 

political subdivisions to make investments that previously had been prohibited. See Acts 

19X7 70th i,eg., ch. 889, at 2985; see also Tex. Const. art. III, $ 52(e); Attorney General 

Opinion DM-202 (1993) at 3. Since its origin81 enactment, the act has authorized political 

subdivisions to which the act applies to invest in “fidly cdllateralized direct repurchase 

‘When 8 aemrilics transaction is “settled,” the delivery of mrtificates from seller 10 buyer actually 

is effected and the bayer has paid for the semrilies. See H. MCCAWLEY, TRANSACTIONS IN STOCK, 

SEcuRllTEs ANO Other FNWCIAL ~NST8LIhfENTS A-4 (1990). The “seulement date” generally is on th$ 

iifth busine.ss day after the buyer and seller have entered into a binding mnuacl to buy and sell the stock. 

Id. 

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agreements.“5 Acts 1985, 70th Leg., ch. 889, 4 2(a)(6), at 2985, umended and 

renumbered by Acts 1993, 73d Leg., ch. 946, 5 1. In public hearings on the 1987 bill, 

Represent8tive Hammond, the author of the bill, stated that the bill “sets out certain 

specilic areas that [the listed political subdivisions] are allowed to invest in.” Hearings on 

H.B. 1488 Before the House Comm. on Financial Institutions, 76th Leg. (Apr. 1, 1987) 

(statement of Representative Hammond, author) (tape available from House Committee 

Services Office). During the hearings on the bill before the House Committee on Financial 

Institutions, legislators expressed concern that the investments listed in the bill be safe and 

prudent. See id. (statements of Representative Hammond and repeated questions from 

Representative Larry). 

In our opinion, the legislature intended the list of permissible investments in section 

2(a) of the act to be specifically delineated and exclusive. Additionally, the legislature 

specifically has considered and approved the riskiness of each of the listed permissible 

investments. We therefore decline to construe “repurchase agreements” in section 2 of the 

act to include covered call contracts and covered put wntracts. Consequently, we 

conclude that section 2(a)(9) of the act does not include covered call contracts and 

wvered put contracts. Because covered call contracts and covered put contracts do not 

fall within any of the investments in section 2(a) of the act that a public timds investment 

pool is permitted to purchase, sell, or invest in, a public timds investment pool may not 

write such contracts. 

51n 1989 the legislature amended the language of what is now section 2(a)(9) to delete the word 

“direct” from the phrase “folly mllateralizcd direct repurchase a’grecmenu.” See Acts 1989,‘Ilst Leg., ch. 

628, 0 1, 81 2099, 2100. Unfortunately, the legislature enacted three other bills in 1989 that amended 

section 2(a), none of which deleted the word “direct” from “folly mllateralized direct repurchase 

agreements’ in what is now subsection (9). See Acts 1989,71st Leg., ch. 39.5 1, at 325,326; id. ch. 693, 

0 4,8l3199,3200; id. ch. 750,@ 1, at 3333.3333. In 1993 the legislatore clearly amended section 2(a)(9) 

to delete the word “direct.” See Acts 1993,73d Leg., ch. 946.8 1. 

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Honorable O.H. “Ike” Harris - Page 7 (DM-274) 

SUMMARY 

A covered call contract and a covered put contract are not, for 

purposes of section 2 of the Public Funds Investment Act, V.T.C.S. 

article 842a-1, lobligations of the United States or its agencies and 

instrumentalities,” ” obligations, the principal of and interest on which 

are unconditionally guaranteed. . by. . . the United States or its 

agencies and instrumentalities.” or “titlly collateralized repurchase 

agreements having a defined termination date.” Thus, section 2 does 

not authorize a public funds investment pool to “purchase, sell, or 

invest its funds and funds under its control” in covered call contracts 

or covered put contracts. 

DAN MORALES 

Attorney General of Texas 

WILL PRYOR 

First Assistant Attorney General 

MARYKELLER 

Deputy Attorney General for Litigation 

RENEA HICKS 

State Solicitor 

MADELEINE B. JOHNSON 

Chair, Opinion Committee 

Prepared by Kymberly K. Oltrogge 

Assistant Attorney General