## THE ATTO~RNEY GENERAL OIF 

### TEXAS

0cl:ober24, 1986

Honorable 0. H. "Ike"&rrj.s Chairman EconomicDevelopmentCommit,tee Texas State Senate P. 0. Box 12068,Capitol Station Austin,Texas 78711

Dear SenatorHarris: OpinionNo. JM-570

Re: Investmentofmunicipal funds inmoneymarketmutual funds

Your letter requesting; the opinion of this office reads:

Pursuant to various statutes, cities in Texas are authorized to invest certain of their municipal 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 consideration, 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.ld be eligible for this type of investment is s],ecificallydesigned for use by banks, fiduciariesand custodiansof public funds. The MMMF would ::nvestonly in short-term United States Treasury ,&linations which mature in less than one year.*An investor such as the citywould
own an individe;-pro rata interest in the portfolio of short-te;mobligationsownedby the fund. This typesof mur;al fund is registered with the Securitiesand ExchangeCommission (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 obligationswould invest only in instruments issued by the United States government or it3 agencies. The securities purchased by the fund must be held by a qualified

p. 2535Honorable 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 inspected periodically by independent public accountants and me subject to inspectionby the SEC. All employt!esof the fund having access to the securities mil:st be bonded. The SEC can and does inspect.the books and records and regulate the accountingpolicies and principalsof the fund and all financia:.statements of the fund must be preparedby independentpublic accountants.
The ownership of governmentobligations 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 securities. 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 appropriaterate of return. In addition, the use of a fund for investment in governmental obligations representsa reduction in the risk inherent in any investme=; and, very importantly, reduces the cost to the #cityfor its investment transaction. In short, itwould appear that investment in an MMMP offers .a11 of the security of ownership of individual securities but further provides other advantages not available through individual ownership. (Empha;sis added).
The city of Arlington is a home rule city; itmay incorporate in its charterand enactby ord.inance anyprovision that is not inconsistent with the general law;3of 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 Baytownv. Angel, 469 S.W.2d 923 (Tex.Civ.Ap:p.- Houston [14thDist.] 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,Lugto the most recent federal census, a category that does not inc:Ludethe city of Arlington. Article 2561, ?

-.

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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 contractbetween 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.t

under the terms of the depository 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 includehome rule cities. It reads:

All political subdivisions of the State of Texas which have balances remaining in their accounts at the end of any fiscalyear may invest such balances in Defense Bonds or other obligations of the Uzfed States of America; provided. however. that ti& such funds are needed the obligations of 1:h.e United States in which such balances are invested shall be sold or redeemed and the proceed;3of said obligations shall be deposited in the:accounts from which they were originallydrawn. (Emphasisadded).
The Texas Legislature 'hasby 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,o be legallyauthorized,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) (stateinvestment authority).

1. Contemporaryamendments to article 2525,V.T.C.S.,were saved from repeal by section 2 cf Acts 1985, 69th Leg., ch. 240, at 1204, enacting theTreasuryAct. SeeActs 1985, 69thLeg., ch. 71, at 488. .-

p. 2537Honorable 0. H. “Ike”Harri;;- Page 4 (m-570)

A “money-marketfund” canbe generallydescribedas amutual fund which typically invests in :short-term debt instrumentssuch as government securities,commercialpaper, and largedenominationcertificates of deposit of banks. A “mutual fund” is a type of investment company which continuouslyoffers shares to thepublic and stands ready to buy back shares whenever an investorwishes 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 investmentcompany”:

An open-end inrestmentcompany -- usuallyknown
as a mutual fund ‘--is a company with a managed portfolio of securities thatwill buy back shares from investors whenever the investor wishes to sell. The redemptionprice dependsupon thevalue 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 companiesmay be purchased through broker/dealers who receivepart XE the sales charge. An open-end investment company is known as a no-load fund if the sellingprice of its sharesdoes not containa 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 :ompanymay charge only a nominal fee for their services.

Id. at 22. See Board of Governors of the Federal Reserve System v. InvestmentCompany Institut;, 450U.S. 46, 51 (1981).
While it may be true as an abstractmatter that an investor in such a fund.owns an undivided pro rata interest in the portfolio of short-term obligationsowned 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 safekeepingor forany otherpurpose.

As Professor Frankel says in 1 Frankel, The Regulation of Money Managers,A 12 at 5 (1978):

Investment coxpanies are designed to offer small investorsexpertmanagement and diversification by pooling wsall investments and entrusting --.

?

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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 obligationsrepresents 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, accountabilityand expertise of the fundmanagers aswell as the financial stabilityand responsibilityof the entitieswhose obligationsare representedin theportfolio of the fund. But that is not the issue. We cannotbase our answer on anticipated 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 themeaning of article 1269j-3,V.T.C.S.

A "government security," is defined by the InvestmentCompanyAct 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 securitiesto a purchaser is an exempt transaction,but the sale of an interest in z.mutual fund dealing in such government securities isnot. SeeV.T.C.S. art. 581-5. subset.M. -
In Bankers FarmMortgage Companyv. 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 1940was enacted, itwas contended that bonds issued by the hankers Joint Stock Land -Bankof 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 plaintiffwas a corporation formed to buy up the bank's outstanding bonds after the bank had defaulted on theirpayment andhad 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 capititl was furnishedby 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 obligationor debt of thebank, andwe 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 forprivate gainwith capitalprovidedby 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 themselvesmay 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 companiesare not charteredt'yCongressormade 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 themeaning 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.sconsidered 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 agreements" involving securities of the United States for short term investments,&, whether an investmentin such repurchaseagreements was an investmentin "direc,: debt securitiesof the United States.'
The opinion concluded that an investment in such repurchase agreements was not the stat:utoryequivalent of investing in direct debt securities of the United States. We reach an analagous conclusionhere. Cf. Attorney General OpinionsMW-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 regulatedby the federal government, even though the fund deals solely in obligationsof theUnited States.

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As amatter of interest,twoproposals to expresslyauthorize the investment of public funds in money market mutual fundswere defeated by the Sixty-ninthLegislature 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 amoney marketmutual fund dealing solely in obligationsof theUnited States.

JACK HIGHTOWER FirstAssistantAttorney General

MARY KELLER ExecutiveAssistantAttorney General

RICK GILPIN Chairman,Opinion Committee
Preparedby BruceYoungblocd AssistantAttorney General

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