THE ATTORSEY GESERAL OF TEXAS

P Honorable 0. H. "Ike** Harris Opinion No. JR-975 Chairman Economic Development Committee Re: Whether public funds Texas State Senate may be invested in bankP. 0. Box 12068 orientedmoneymarket mutual Austin, Texas 78711 funds pursuant to article 842a-2,V.T.C.S. (RQ-1345)

Dear Senator Harris:

Your letter requesting an opinion from this office reads in part:

The 70th Legislature of Texas passed House Bill 1488 enacting The public Funds Investment Act of 1987, now codified in Article 842a-2, Vernon's Annotated Texas Civil Statutes (the 'Act'), in order to grant public bodies an expansion of their investment authority. As a sponsor in the Senate of the companionbill to H.B. 1488and as Chairman of the Committee on Economic Developmentwhich heard and passed suchbill, I have received a number of inquiries from representativesof public bodies and financial institutionsas to the proper interpretation of Section 2(b) of the Act which authorizes investment of bond proceeds in

‘Common trust funds or COmDarable investment devices owned or administered bv banks domiciled in this State' (emphasis added) which consist solely of certain eligible obligationsdescribed in the Act ('Eligible Obligations'). (Emphasisin original.)

. . . .
In [AttorneyGeneral Opinion] JM-570, YOU held that traditional money-market mutual fund shareswere not eligible for investment of city funds (even though the funds were restricted to holding federal securities) because no Texas statute authorized such

P. 4960Honorable 0. H. "Ike" Harris - Page 2 (JM-975)

investment. The question now iswhether H.B. 1488 succeeded in overcoming #at statutory deficiency if the mutual fund is an integral part of a Texas bank'smanagement and investment services. Accordinalv.vour oninion is resnectfullv reauested as to whether a bank-orientedmonev marketmutual fund of the tvne described below constitutesa 'comnarable investment device owned or administered bv a bank domiciled in this State.' within themeanina of the Act. such that a DubliC bodv that otherwise comnlieswith the recuirements of the Act **mav** lawfullv invest its bond nroceeds in such fund. (Emphasis added.)

**Common

trust funds

. . .administered,bybanks" refers to the classification of funds excluded from the definition of "investmentcompany" by the Federal Investment Company Act of 3.940,

referring to **any common trust fund or similar fundmaintained by a bank exclusively for the collective investmentand reinvestment ofm‘oneyscontributedthereto by the bank **in** its.capacity as a trustee, executor,administrator,~or guardian." 15U.S.C. 5 8Oa-3(c)(3);~99 Prop. Code § 113.171;Shannon **v. Frost**  Nat'1 Bank of San Antonio, 533 S.W.Zd 389 (Tex.Civ. APP. - San Antonio 1975,writ ref'd n.r.e.). It is explained:

Basically, the common trust funds maintained by banks are investmentcompanies in purpose andmode of operation, and, without the exception in the 1940 Act, theywouldbe regulated by the Act.

T. Frankel, 1 The Regulation of MoneyManagers, ch. V(G)t 5 10.2, at 422.

As your letter requesting an opinion advises, the

**common** trust fund typically sells units of participation in the fund, each representing an equal,undivided interest in its portfolio of securities, and, in the event of a dissolution of a common trust fund, the ownersof units of participation will receive, pro rata, subject to the rights of creditors, the proceeds of such sale lessthe liabilities of the fund. As described, participation in such funds is similar to the participation of shareholdersin corporations organized **for** private gain. In Presnallv. Stockyards Nat'1 Bank the court said:

It is generally agreed that shares in an incorporated company are the aliguotparts of

P. 4961Honorable 0. H. "Ike" Harris - Page 3 (JM-975)

the capital stock, and merely give to the
owner a right to his shareof the profits of the corporationwhile it is a going concern and to a share of the proceeds of its assets when sold **for** distribution in case of its dissolution and windingup. The shares do not give to their owners any right in the property itself of the company. That remains in the artificial body called the corporation. The right of the individual shareholder, according to the amount put into the fund of the corporation, is therefore of an incorporeal nature, though of value, not capable of manual delivery.

151 S.W. 873, 076 (Tex.Civ.App. -Texarkana 1912), aff'd, 194 S.W. 384 (Tex. 1917).

Your specific question asks whether a bank-oriented money market mutual fund "of the type described below" constitutes a "comparable investmentdevice"within the meaning of the public Funds Investment Act of 1987, and you draw severalparallels between the particular fundyou describe and a "common trust fund." Ifwe assume the bank-oriented money market mutual fund to be "a comparable investment device," a question arises as to whether it is an "individual, association or corporation" to which political corporations and subdivisions are forbiddento lend credit or in which they cannotbecome stockholders.

Article III, section 52(a), of the Texas Constitution reads:

Sec. 52 (a) Except as otherwiseprovided

by this section, the Legislature shall have
no power to authorize any county, city, town or otherpolitical corporationor subdivision of the State to lend its credit or to grant publicmoney or thing of value in aid of, or to any individual, associationor corporation whatsoever, or to become a stockholder in such corporation, association or company. However, this section does not prohibit the
use of public funds or credit for the payment of premiums on nonassessable life,health, or accident insurancepolicies and annuity contracts issuedby a mutual insurance company authorized to do business in this State.

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None of the later-statedexceptions in section 52 embrace loans to, or investmentsin,private enterprisesor their shares.

If nunits of participation" in a mutual fund are the equivalent of shares of stock in a corporation, association
or companywithin the contemplation of article III, section 52, of the Texas Constitution,such investmentscannot be authorized by the legislature.See Lewis v. Indeoendent School District of Austin, 161 S.W.2d 450, 452 (Tex. 1942). See also Citv of Tvler v. Texas EmDlOYerS' Ins.Ass'n, 288 S.W. 409 (Tex.Comm'nApp. 1926 judgment adopted),aff'd on rehearinq, 294 S.W. 195 (1927).1

In InvestmentComDanv Institute **v. Camp,**  **401** U.S. 617 (19711,the United States Supreme Court consideredthe plan of a national bank to go into the business of operating a mutual investment fund. As described by the court:

Under theplan the bank customer tenders between $10,000 and 5500,000 to the bank, togetherwith an authorization making the bank the customer's managing agent. The customer's investment is added to the fund, and a written evidence **of** participation is issuedwhich exnresses in 'unitsof narticipation' the customer'sDroDortionate interest in fund assets. Units of participation are freely redeemable,and transferable to anyone who has executeda managing agency agreement with the bank. The fund is registeredas an

1. Monies paid to banks for such investment purposes are not the equivalent of "deposits." In Lawsonv. Baker, 220 S.W. 260 (Tex.Civ.App. - Austin 1920,writ ref'd), the state depository statute was attacked on grounds that the placement of state fundson deposit with banks amounted to
an unconstitutional loan or investment of public funds. The court concluded that deDOSitS authorized by the statute in question were not loans or investments. It reached that conclusion by reasoningwith other jurisdictionsthat

the general depositing of money in a bank depository,with or without interest, subject to tZ check or demand of the depositor, is not a loan or investment.

u. at 269.

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investment company under the Investment Company Act of 1940. The bank is the underwriter of the fund'sunits of participation within the meaning of that Act. The fund has filed a registrationstatement pursuant to the Securities Act of 1933. The fund is supervised by a five-membercommittee elected annually by the participantspursuant to the Investment CompanyAct of 1940. The Securities and Exchange Commissionhas exempted the fund from the Investment CompanyAct to the extent that a majority of this committee be affiliated with the bank, may and it is expected that a majority alwayswill be officers in the bank's trust and investment division. The actual custody and investment of fund assets is carried out by thebank as investment advisorpursuant to a management agreement. (Emphasisadded.)

401U.S. 617, at 622-623.

A federal lawprovided that a nationalbank "shall not underwrite any issue of securities or stock.tl 12 U.S.C. § 24. After observing that a bank which operates an investment fund has a particular investment to sell, the court held that the operation of the investmentfund involved a bank in the underwriting, issuing, sellingand distributing of securities in violation of the federal law as it then read. BK!R, 401 U.S. 617,at 639.

In the course of reaching its decision, the court noted:

A IiIUtUal fund is an ODen-end investment comw. The Investment Company Act of 1940 defines an investmentcompany as an 'issuer' of 'any security'which 'isor holds itself out as being engaged primarily in the business of investing

. . . in' * ' securi- ties .' 80a-3(i)'(i)

. 15 U.S.C. 55 80a-2(a)(21),

An open-end company is one 'which is offering for sale or has outstanding any redeemable securityofwhich it is the issuer.' investment 15U.S.C. 5 80a-5(a)(l). An

comnanv also includes a \unit investment trust': an investment comoany which. among other thinas. 'is oraanized under a
. . .contract of

. . .aaencv
. . and

. . . issuesonly redeemable securities: each of which renresents an .undivided

P. 4964Honorable 0. H. *Ike"Harris - Page 6 (JM-975)

? interest in a unit of snecified securities .' Added.) 15 U.S.C. 5 80a-4(2). (Emphasis

&j at 625 n. 11.

The characterization of a "unit of participation" by the United States Supreme Court as a "proportionate interest in the fund assets" could be fairlyused as a description, also, of a share of stock. m Presnallv. StockvardsNat'1 &&, sutxq. Section 52 of article III of the Texas Constitution prevents a county, city or othermunicipal corporation from becoming Ita stockholderl'in a "corporation, association or company." Ithas been suggested, however, that units of participation in bank-orientedmoney market mutual funds are not the functionalequivalents of shares of stock in a profit-seeking enterprise,and that holders of certificates evidencing ownership of such participatory interestswould not be V1stockholdersV* within the meaning of the constitution.

The argument suggests thatunits of participation in a portfolio consisting of governmentalobligations are not equivalent to shares of stock within the constitutional prohibitionbecause they are not shares of bank stock, they
are not interests in a portfolio of securities consistinq of stock in a private corporation,associationor company, and the fund itself is not a corporation. However, it must be admitted that such funds, thoughnot organized as corporations, are private enterprisesoperated forprofit or gain, that money invested in such an enterprise isput at risk in
a commonventure, that the securities in the portfolio of the fund (whetherconsisting of stocks of private corporations or of governmentbonds) aremerely the assets of the fund and not themselves the enterprise,and that return on the investmentdepends upon how those assets are~~used by fundmanagers.

In Attorney General OpinionJM-570 (1986),to which you refer, we advised that money market mutual funds, including those that deal only ingovernment securities, are private enterprises operated forprivate gain. We also said:

While itmay be true as an abstractmatter

that an investor in such a fund owns an undivided pro rata interest in the portfolio of short-term obligationsownedby 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 --.

P. 4965Honorable 0. H. **Ikell Harris - Page 7 (JM-975)

rata interest in the machinery, buildings, and other assets of the manufacturer. The investor can exercise no personal control
over the portfolio of the fundor its disposition, and has no right to reduce to possession any part of it for safekeepingor for any other purpose.
Attorney General Opinion JM-570 (1986), at 5. It was also noted there that an investor in such a fund assumes risks as to the fidelity, accountabilityand expertise of the fund managers as well as the financial stabilityand responsibility of the entities whose obligationsare represented in the portfolio of the fund. Cf. Attorney General Opinion JM-23 (1983) (repurchaseagreements).
Although we concluded in Attorney General Opinion JM-570 (1986)that statutesadvanced thereby proponents to support investment of public funds in the securities (includingparticipatory **units@') of private entities did not provide that support, we did not suggest that statutes purporting to do so, if enacted,would face no constitutional hurdles. Attorney General Opinions (1988):JM-832 (198F; JM-545 (1986);JM-23 (1983)' x4-932

- (1980) (constitutionalissuenot addressed). The ente$iii representedby a mutual fund such as you describe is one of individuals or entities privategain. associated for the purpose of

Although the fund is not incorporated, it is
an "association" or "company" within themeaning of the Texas Constitution. Mills v. State, 23 Tex. 295 (1859).

InMills v. State,m, the Texas Supreme Court had occasion to examine a provision of the 1845 Texas Constitution that provided, "No cornoratebodv shallhereafter be created, renewed, or extended, privileges." with banking or discounting

(Emphasisadded.)Tex. Const., art. VII, 5 30 (1845). In 1840, the legislatureenacted a law declaring "[t]hat any Cornoration. Comnanv. or Asssociation of individualswho shall use or exercisebanking or discounting privileges in this State,

. . . shall be deemed guilty." (Emphasisadded.) An Act to Suppress Illegal Banking,Acts 1840, ch. 156, g 1, at 234. The court said:

We think that the statute of 1040, to suppress illegalbanking,was enacted for the purpose of carrying into effect this 30th section of the General Provisions of the Constitution. And inasmuch as the exercise of bankina and discountina orivileses. by comnanies and associations of individuals. was a violation of the snirit of the

P. 4966Honorable 0. H. "Ike"Harris - Page 0 (JM-975)

constitution, iust asmuch as the exercise of the like nrivileaes bv a cornoration. the

cornorate bodies. but also to comnanies, and associations of individum. (Emphasis added.)

Id. at 302-303. The court said the word, Vompany,'* as used, applied to persons actingtogether for theprosecution of enterprises, and that the word, "association,"was used
as a synonym for Vompany." Those words signified, the court concluded,persons acting together, through officers
or agents, in the prosecutionof important enterprises. Id. at 303-304.
Scarcely fifteenyears later,using words given meaning by the Mills court, section 52 of article III of the 1876 Constitutionwas written to deprive the legislatureof power to authorize any political subdivision to become a "stockholder" in a *'corporation, associationor company." In that era, nstock'*

broadly referredto the capital of an enterprise. The 1859 edition of Bouvier's Law Dictionarydefined "stock" as:

The capital of a merchant, tradesman, or other person, including his merchandise, money and credits. In a narrower sense it signifies only the goods and wares he has for sale and traffic. The capital of corporations is also called stock: this is usually divided into shares of a definite value, as one hundred dollars, fiftydollars per share.

2 Bouvier's Law Dictionary (8thed. 1859), at 550.

In the light of Mills v. State, the referenceplaced in the new constitution to ustockholders'O in associations -and companies (as well as to stockholders in corporations), exhibited a plain determinationthat its prohibition should reach participation in non-corporate,private enterprises of aggregated capital. That is the construction given the provision by the Texas courts. Lewisv. Indenendent School District of Austin, sunrq; WcCalebv. Continental Casualty Co., 116 S.W.Zd 679 (Tex.1938); Southern Casualty Co. v. Moruan, 12 S.W.2d 200 (Tex.Comm'n App. 1929, judgment adopted): Citv of Tvler v. Texas EmDlovers' Ins. Ass'n, sunra.
The leading case, Lewisv. Indenendent School District of Austin m, was decidedby the Supreme Court of Texas in i942before the current final sentencewas added to -,

P. 4967Honorable 0. H. *'Ike" Harris - Page 9 (JM-975)

article III, section 52(a) by amendment (November4, 1986, allowing the purchase of certain mutual policies with public funds),but it did not break new ground. It followed
a well marked furrow.

In 1916, the Texas Supreme Court, inMiddleton v. Texas Power & Liaht Co., 185 S.W. 556 (Tex.1916), said that the Texas Employers InsuranceAssociation (legislativelycreated in conjunctionwith the enactment of the Workmens' Compensation Law)was not a private corporationbut, instead, was only an agency forproper administrationof the law notwithstanding itsdesignationby the legislatureas a "corporation." Id. at 562. (It issued no stock or certificates of ownership and, in fact,was not l'ownedl* by anyone in the usual sense,but its "subscribers"aggregated their capital to operate it as a vehicle for their common advantage, sharing in its success to the extent it relieved them of obligations.) A decade later, the Commission of Appeals held in Citv of Tvler v. Texas EmDlOVSrS’ Ins.Ass'n, suora, that the ~~stockholder~~ provision of article III,section 52, prohibited the legislature from permittingpolitical subdivisions to becomemembers of the association. The court said the organizationwas 'a corporationengaged in the insurancebusiness on the mutual plan,whose subscribers are stockholders in such corporation.' Id: at 412. For that reason, the court said, the constitution forbade cities and towns from "becomingstockholders therein." Id.

On rehearing,the Commission of Appeals denied that it had overruledtheMiddleton case. The court said the point in the Middleton case was that the association was not a corporationwithin the meaning of the general law authorizing corporations, but that it did not follow that the associationdid nothave elements of a private corporation, concluding:

We havemerely indicated oursopinion that the nature of such association,whether 'technicallv a cornoration or not,' is such that municipal corporations cannot become subscriberstheretowithout violating constitutional limitations. (Emphasisadded.)

CitV of Tvlerv. Texas EmDlovers8 Ins.Ass'n, 294 S.W. 195, 196.

Later, in Southern Casualty Co. v. Moraan, sunra, the Commission of Appeals read the City of Tvler court to have held:

p. 4968Honorable 0. H. aIke*' **Harris -**  Page 10 (JM-975)

[T]heLegislature is withoutpower (section 52, art. 3, Constitution) to authorize a municipal corporation of the kind involved~to become,in effect, a 'stockholder' in the Texas Employers' InsuranceAssociation (substantiallya 'mutual‘ company),and thus to 'lend its credit,' etc., or tomake the 'appropriation of public money' (held to be a gratuity)necessary to affecting insurance. (Emphasisadded.)

12 S.W.Zd 200. Later still, the Texas Supreme Court explained the Citv of Tvler holding. The court said in McCalebv. Continental Casualty Co:

Itwas also held that by virtue of section 52 of article 3 of our Constitution, Vernon's Ann. St. Const. art. 3, 5 52, municipal corporationscould not take out a policy of insurance in a mutual insurance- companywhich would require a city to become a member of or stockholder in such insurance company. (Emphasisadded.)

116 S.W.2d 679, 680 (Tex. 1938).
Nevertheless,when the Lewis case camebefore the Court of CivilAppeals in 1941, the intermediatecourtwas persuaded that the Citv of Tvler and Southern Casualty Co. holdingswere merely "obiter"to be dismissedas not controlling. Lewisv. IndenendentSchool District, 147 S.W.2d 298, 303 (Tex.Civ. App. - Beaumont 1941),rev'd, 161 S.W.Zd 450 (Tex. 1942). The appeals court concluded that the schooldistrict in the Lewis casemade ~g loan of its credit to the mutual insurance company fromwhich it purchased workmen*9 compensation coverage, that the school district did nnf;

become a stockholder in the insurancecompany or a **subscriber to**  **its** capital stock by itspurchase of the insurancepolicy, and it quoted froma North Carolina case to the effectthat a YstockholdeY is the owner of shares in
a corporationhaving capital stock representedby shares, and that amutual company iswithout "stock"or "stockholders"

. && at 302.

When the Lewis case reached the Texas Supreme Court, the court characterized the questionaswhether the legislature could constitutionallyauthorizethe school district, a political corporation, to purchase a policy of mutual insurance. Citing the Citv of Tvlel:case, among others, it said:

P- **4969**Honorable 0. H. "Ike"Harris - Page 11 (JM-975)

This Court has held that Section 52 of Article 3 of our Constitution prohibits cities from becoming members of a mutual insurance association whose subscribers are stockholders in such company. Lewis, 161 S.W.Zd 450, 452.

It held the school district to be prohibited by the Texas Constitution from taking a policy in the mutual company, saying:

The lancuase used in the Constitution is

clear and unambiauous. It soecificallv nrohibits the School District from becomina a stockholder in a corooration, association. or comnanv. Whether the public policy announced in the Constitution iswise or unwise is not for this Court to decide. As said by Judge Speer, in the case of City of Tyler v. Texas Employers Ins.Ass'n., Tex.Com.App., 294 S.W. 195, 197:

'It is not a question of expediency, for upon that pointwe might all agree, but expediency cannot substitutethe judgment of the municipality for that of the judgment of the framers of the Constitution. public policy cannot be contrary to the express provisions of the Constitution. When that instrument speaks, thematter is indelibly settled, and itswisdom cannotbe questioned.' (Emphasis added.)

Id. at 452-453.

We are persuaded that %nits of participationI' in a mutual fund operated as a private enterprise, whether "bank-oriented" or not, are the shares of stock within the functional equivalents of meaning of article III, section 52 of the Texas Constitution. As a consequence, it is not within the power of the Texas Legislature to permit municipalities to invest public funds therein and to thereby become nstockholdersV' in an association or company within the meaning of that provision.

In 1986, subsection (a)of article III, section 52 w.as amended to add a final sentenceto the general prohibition:

However, this section does not prohibit the
use of public fundsor credit for the payment

P. 4970Honorable 0. H. "Ike"Harris - Page 12 (JM-975)

of premiumson nonassessable life,health or accident insurance policies and annuity contracts issued by a mutual insurance companyauthorized to do business in this state.
Although the 1986 amendment added a sentence which now expressly allows the use of public funds to purchase certain mutual policies,the amendment did not otherwisealter the scope of the constitutional prohibition, andwe believe it continues to prohibit the investment of public funds in other private enterprises of aggregated capital, whatever might be theirnomenclature.

In recentyears, the courts of other stateshave accorded a similarreading to prohibitory provisions found in their own constitutions. See In re J.iOn CaDital GrOUD 49 Bankr. 163 (S.D.N.Y.1985): Board of Trusteesof the P;blic EmDlOVees' RetirementFund of Indiana v. Pearson, 459 N.E.2d 715 (Ind.1984); PublicHousina Administrationv. Housinq Authoritv of Boaalusa, 137 So.Zd 315 (La. 1961). a. Louisiana State EmDlOVeSS’ Retirement Svstemv. State, 423 So.2d 73 (La.Ct. App. - [letCir.] 1982),writ denied, 427 So.2d 1206 (1983). ,~.

In our opinion, insofar as the Public Funds Investment Act of 1987 (article842a-2,V.T.C.S.) purports to authorize political corporationsand political subdivisionsto invest public funds inbank-oriented money marketmutual funds or securities of private entities, it conflictswith the constitutionalprovision.

SUMMARY

Insofar as article 842a-2, the Public Funds Investment Act of 1987, purports to authorizepolitical corporations and political subdivisions to invest public funds in bank-orientedmoney market mutual funds or other securities of private entities, it conflictswith article III, section 52, of theTexas Constitution. I

AttorneyGeneral of Texas ?

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MARY KELLER FirstAssistant Attorney General

mu MCCREARY ExecutiveAssistant AttorneyGeneral

JUDGE ZOLLIE STEAKLEY SpecialAssistant Attorney General

RICK GILPIN Chairman, Opinion Committee
Preparedby Bruce Youngblood Assistant Attorney General

P. 4972