            THE        ATTO~RNEY        GENERAL
                          OIF   TEXAS

                         0cl:ober24, 1986




Honorable 0. H. "Ike" &rrj.s                Opinion No. JM-570
Chairman
Economic Development Commit,tee             Re: Investment of municipal
Texas State Senate                          funds in money market mutual
P. 0. Box 12068, Capitol Station            funds
Austin, Texas   78711

Dear Senator Harris:

    Your letter requesting;the opinion of this office reads:

            Pursuant to various statutes, cities in Texas
         are authorized to invest certain of their muni-
         cipal 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 considera-
         tion, 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.ldbe 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 port-
         folio 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 pur-
         chased by the fund must be held by a qualified


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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 in-
          spected   periodically   by   independent public
          accountants and me subject to inspection by the
          SEC. All employt!esof the fund having access to
          the securities mil:stbe 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 securi-
          ties. 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 obliga-
          tions represents a reduction in the risk inherent
          in any investme=; and, very importantly, reduces
          the cost to the #city for its investment trans-
          action. In short, it would appear that investment
          in an MMMP offers .a11of the security of ownership
          of individual securities but further provides
          other advantages not available through individual
          ownership. (Empha;sisadded).

     The city of Arlington is a home rule city; it may incorporate in
its charter and enact by ord.inanceany provision that is not inconsis-
tent 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:Ludethe city of Arlington. Article 2561,



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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.tunder the terms of the deposi-
            tory 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 obliga-
          tions of the Uzfed States of America; provided.
          however. that ti&    such funds are needed the
          obligations of 1:h.eUnited 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,obe 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-termdebt instruments such as govern-
ment 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 diversifica-
          tion by pooling wsall investments and entrusting


                               p. 2538
                                 .

    .
        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 anti-
        cipated 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
                                                                         ,

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 capititlwas 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'yCongress 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 agree-
ments" 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




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