THE ATTO~RNEY GENERAL 

OIF TEXAS 

0cl:ober 24, 1986 

Honorable 0. H. "Ike" &rrj.s 

Chairman 

Economic Development Commit,tee 

Texas State Senate 

P. 0. Box 12068, Capitol Station 

Austin, Texas 78711 

Dear Senator Harris: 

Opinion No. JM-570 

Re: Investment of municipal 

funds in money market mutual 

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],ecifically designed for use by 

banks, fiduciaries and custodians of public funds. 

The MMMF would ::nvest only in short-term United 

States Treasury ,&linations which mature in less 

than one year.* An investor such as the city would 

own an individe;-pro rata interest in the portfolio of short-te;m obligations owned by the fund. 

This types of mur;al fund is registered with the 

Securities and Exchange Commission (SEC) under the 

Investment Company Act of 1940 and their shares 

are registered wder the Securities Act of 1933. 

A fund for U.S. Treasury obligations would invest 

only in instruments issued by the United States 

government or it3 agencies. The securities purchased by the fund must be held by a qualified 

p. 2535 
Honorable 0. H. "Ike" Harris - Page 2 (JM-570) 

bank or other institution acting as custodian of 

the government securities which are in fully 

negotiable form ~without restrictions, are inspected periodically by independent public 

accountants and me subject to inspection by the 

SEC. All employt!es of the fund having access to 

the securities mil:st be bonded. The SEC can and 

does inspect.the books and records and regulate 

the accounting policies and principals of the fund 

and all financia:. statements of the fund must be 

prepared by independent public accountants. 

The ownership of government obligations through 

the vehicle of an MMMP as opposed to ownership of 

individual securities is advantageous to the city 

in several respects. It first provides the city 

with a more effjcient cash management tool than 

does traditional ownership of individual 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 

appropriate rate of return. In addition, the use 

of a fund for investment in governmental obligations represents a reduction in the risk inherent 

in any investme=; and, very importantly, reduces 

the cost to the #city for its investment transaction. In short, it would 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; it may incorporate in 

its charter and enact by ord.inance any provision that is not inconsistent with the general law;3 of the state or with the constitution. 

Tex. Const. art. XI. 55; V.T.C.S. art. 1165. See 40 Tex. Jur. 2d 

Municipal Corporations 1326 (1976). But such cxes are precluded 

from entering a field of legislation occupied by general legislative 

enactments. Prescott v. City of Borger, 158 S.W.2d 578 (Tex. ci~. 

APP. - Amarillo 1942, writ cef'd). See also City of Baytown v. Angel, 

469 S.W.2d 923 (Tex. Civ. Ap:p. - Houston [14th Dist.] 1971, writ ref'd 

n.r.e.). 

Of the three statutes mentioned by your letter, article 1182g, 

V.T.C.S., is applicable o,n:.y to home rule cities having a population 

of 900,000 or more accord,Lug to the most recent federal census, a 

category that does not inc:Lude the city of Arlington. Article 2561, 

? 

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P. 2536 
Honorable 0. H. "Ike" Harris - Page 3 (m-570) 

V.T.C.S., applicable to home rule cities as well as others, states in 

subsection (b): 

(b) Unless espressly prohibited by law or 

unless it is in contravention of any depository 

contract between a city, town, or village and any 

depository bank. the governing body of a city, 

town, or village may direct the treasurer of the 

entity to: 

(1) withdraG any amount of funds of the 

entity that am deposited in a depositqry and 

that are not. required immediately to pay 

obligations o:i the entity or requried to be 

kept on dep0si.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 include home rule cities. It reads: 

All political subdivisions of the State of 

Texas which have balances remaining in their 

accounts at the end of any fiscal year may invest 

such balances in Defense Bonds or other 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;3 of said obligations shall be 

deposited in the: accounts from which they were 

originally drawn. (Emphasis added). 

The Texas Legislature 'has by these statutory provisions enacted 

general legislation controlling the type of securities in which the 

funds of home rule cities may be invested. The investment practices 

of the city of Arlington, t,o be legally authorized, must be consistent 

therewith. Prescott v. City of Borger, m. Cf. V.T.C.S. art. 

2549(c) (county investment%thority): V.T.C.S. artn413(34c) (rules 

gove%ng lpcai funds); V.T.C.S. arc. ~2525, 54(a)(4) (state investment 

authority). 

1. Contemporary amendments to article 2525, V.T.C.S., were saved 

from repeal by section 2 cf Acts 1985, 69th Leg., ch. 240, at 1204, 

enacting the Treasury Act. See Acts 1985, 69th Leg., ch. 71, at 488. .- 

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

A “money-market fund” can be generally described as a mutual fund 

which typically invests in :short-term debt instruments such as government securities, commercial paper, and large denomination certificates 

of deposit of banks. A “mutual fund” is a type of investment company 

which continuously offers shares to the public and stands ready to buy 

back shares whenever an investor wishes to sell. See Handbook, U.S. 

Securities and Exchange Colmnission, What Every Invzor Should Know 

at 29 (1986). As your letter notes, a mutual fund is an “open-end 

investment company”: 

An open-end inrestment company -- usually known 

as a mutual fund ‘-- is a company with a managed 

portfolio of securities that will buy back shares 

from investors whenever the investor wishes to 

sell. The redemption price depends upon the value 

of the company’s portfolio at that time (the ‘net 

asset value’). There is no secondary trading 

market for the sbures of such companies. 

When the selling price of the shares of an 

open-end company includes a sales charge, the 

company is known as a load fund. Shares of such 

companies may be purchased through broker/dealers 

who receive part XE the sales charge. An open-end 

investment company is known as a no-load fund if 

the selling price of its shares does not contain a 

sales charge. Shares of such a fund usually may 

be purchased directly from the investment company 

or its underwriter. Broker/dealers who sell 

shares of such a :ompany may charge only a nominal 

fee for their services. 

Id. at 22. See Board of Governors of the Federal Reserve System v. 

Investment Company Institut;, 450 U.S. 46, 51 (1981). 

While it may be true as an abstract matter that an investor in 

such a fund. owns an undivided pro rata interest in the portfolio of 

short-term obligations owned by the fund, it is true only in the same 

sense that an investor in the stock of a manufacturing concern can 

be said to own an undivided pro rata interest in the machinery, 

buildings, and other assets of the manufacturer. The investor can 

exercise no personal control over the portfolio of the fund or its 

disposition, and has no ri&t to reduce to possession any part of it 

for safekeeping or for any other purpose. 

As Professor Frankel says in 1 Frankel, The Regulation of Money 

Managers, A 12 at 5 (1978): 

Investment coxpanies are designed to offer 

small investors expert management and diversification by pooling wsall investments and entrusting 

--. 

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p. 2538 
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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 obligations represents a reduction in the risk inherent in 

any investment is subject to question. The investor in such a fund 

assumes risks as to the fi'lr~lity, accountability and expertise of the 

fund managers as well as the financial stability and responsibility of 

the entities whose obligations are represented in the portfolio of the 

fund. But that is not the issue. We cannot base our answer on 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 the meaning of article 1269j-3, V.T.C.S. 

A "government security," is defined by the Investment Company Act 

of 1940 to be 

any security issued or guaranteed as to principal 

or interest by the United States, or by a person 

controlled or supervised by and acting as an 

instrumentality of the Government of the United 

States pursuant to authority granted by the 

Congress of the United States; or any certificate 

of deposit for any of the foregoing. 

15 U.S.C. 580a-2(a)(16). It is noteworthy that under the Texas 

Securities Act, article 581-1, et. seq., V.T.C.S., a direct sale of 

government securities to a purchaser is an exempt transaction, but the 

sale of an interest in z. mutual fund dealing in such government 

securities is not. See V.T.C.S. art. 581-5. subset. M. - 

In Bankers Farm Mortgage Company v. United States, 69 F.Supp. 197 

(U.S. Ct. Cl. 1947). cert. denied, 331 U.S. 831 (1947). a case which 

arose before the Investmenf: Act of 1940 was enacted, it was contended 

that bonds issued by the hankers Joint Stock Land -Bank of Milwaukee 

were obligations of the United States because the bank was organized 

and existed under a federal charter pursuant to an act of Congress 

which declared such bonds "instrumentalities of the United States 

p. 2539 
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Honorable 0. H. "Ike" Earrib - Page 6 (x4-570) 

Government" and exempt from taxation. The plaintiff was a corporation 

formed to buy up the bank's outstanding bonds after the bank had 

defaulted on their payment and had become insolvent. 

The Bankers Farm MortSage Company court observed that the bank, 

which loaned money to far&s for profit, was organized for private 

gain and that all its capititl was furnished by private investors. The 

Court held the bonds not to be obligations of the United States, 

saying: 

Neither the statute nor the bonds contain any 

express promise by defendant [the United States] 

to pay the bonds, or to become liable for any 

other obligation or debt of the bank, and we think 

no such obligation can be inferred or implied in 

the circumstances, 

69 F. Supp. at 202. 

Open-end money market investment companies (mutual funds) are 

organized for private gain with capital provided by private investors, 

and the United States has made no express or implied promise to be 

liable, or to become liable, for the obligations of such companies 

notwithstanding that the caq'anies themselves may invest in government 

securities and are subject to federal regulatory control. See 15 

U.S.C. §80a-1 et seq. (the Investment Company Act of 1940)FThe 

investment of funds in obligations or shares of such companies (which 

companies are not chartered t'y Congress or made tax exempt and are not 

by Congress made instrumentalities of the government) is not= 

investment of funds in obligations of the United States of America 

within the meaning of article 1269j-3, V.T.C.S., nor an investment in 

direct debt securities of the United States within the meaning of 

article 2561(b)(2), V.T.C.S. 

A similar question wa.s considered by this office in Attorney 

General Opinion .JM-23 (158,3). There, a statute (since amended) 

authorized counties to invest idle funds only in "direct debt 

securities of the United !;t:ates. 11 See V.T.C.S. art. 2549(c). The 

question was whether Dallas County might utilize "repurchase agreements" involving securities of the United States for short term 

investments, &, whether an investment in such repurchase agreements 

was an investment in "direc,: debt securities of the United States.' 

The opinion concluded that an investment in such repurchase 

agreements was not the stat:utory equivalent of investing in direct 

debt securities of the United States. We reach an analagous 

conclusion here. Cf. Attorney General Opinions MW-343 (1981); MW-224 

0980). In our opinion' tht! existing statutes of this state do not 

authorize the city of Arlington to invest its funds in a money market 

mutual fund regulated by the federal government, even though the fund 

deals solely in obligations of the United States. 

p. 2540 
Honorable 0. H. "Ike" Harris - Page 7 (JM-570) 

As a matter of interest, two proposals to expressly authorize the 

investment of public funds in money market mutual funds were defeated 

by the Sixty-ninth Legislature in 1985. See S.B. No. 766, 69th Leg. 

(1985); H.B. No. 2078, 69th :Leg. (1985). - 

SUMMARY 

The existing statutes of this state do not 

authorize the city of Arlington to invest its 

funds in a money market mutual fund dealing solely 

in obligations of the United States. 

JACK HIGHTOWER 

First Assistant Attorney General 

MARY KELLER 

Executive Assistant Attorney General 

RICK GILPIN 

Chairman, Opinion Committee 

Prepared by Bruce Youngblocd 

Assistant Attorney General 

p. 2541