                                            February 26,1999



The Honorable Judith Zaffirini                         Opinion No. X-0004
Chair, Human Services Committee
Texas State Senate                                     Re: Whether a county is authorized to invest
P.O. Box 12068                                         county permanent school fund proceeds in “pass-
Austin, Texas 78711                                    through’mortgage-backed securities at aninterest
                                                       rate that is below market rate for comparable
                                                       securities to assist in providing low-income
                                                       housing in the county (RQ-887)

Dear Senator Zaftirini:

         On behalf of Webb County, you ask whether a county is authorized to invest county
permanent school fund proceeds in “pass-through’ mortgage-backed securities’ at an interest rate
that is below market rate for comparable securities. Your request letter suggests that the crucial legal
question is whether the contemplated investment is authorized by the Public Funds Investment Act,
TEX. GOV’T CODE ANN. ch. 2256 (Vernon 1999), particularly Government Code sections 2256.009
and 2256.024. We do not reach the Public Funds Investment Act, however, because we conclude
that article VII, section 6 of the Texas Constitution precludes the county from making such an
investment on behalf of the county permanent school fund.

        Article VII, section 6 provides in pertinent part that county school lands “and the proceeds
thereof, when sold, shall be held by said counties alone as a trust for the benefit of public schools
therein; said proceeds to be invested in bonds of the United States, the State of Texas, or counties
in said State, or in such other securities, and under such restrictions as may be prescribed by
law.     .” TEX. CONST. art. VII, 5 6. Numerous court opinions and opinions of this office treat a
county permanent school fund as a trust and stress the fiduciary nature of a county’s duty to invest
the county permanent school fund on behalfofpublic schools in the county. See, e.g., Delta County
v. Blackburn, 93 SW. 419, 422 (Tex. 1906) (counties are trustees for benefit of state’s public
schools); Comanche County Y.Burks, 166 S.W. 470,473-74 (Tex. Civ. App.-Fort Worth 1914, writ
ref d); County School Trustees v. Brazoria County, 240 SW. 675,676 (Tex. Civ. App.-Galveston
 1922, no writ) (county held fund as trustee for schools); see also Tex. Att’y Gen. Op. Nos. H-506



         ‘The term “pass-through” is used to describe a mortgage-backed security for which the payments on the
underlying mortgages are passed from the mortgage holder through the servicing agent to the security holder. The
servicing agent usually keeps a portion of the payments as a fee. See DAWD A. FRANKLIN,GLOSSARYOF PUBLIC
FINANCETERMINOLOGY
                 30 (1992).
The Honorable Judith Zaffirini - Page 2          (JC-0004)




(1975) at 2 (county commissioners court acts in fiduciary capacity as trustee of permanent school
fund), H-239 (1974) at 1 (“The county permanent school fund is impressed with a trust in favor of
the local inhabitants and schools, and the commissioners court administers the fund as trustee, with
the duties oftrustee.“), M-l 104 (1972) (applying Texas Trust Act to county permanent school fund),
V-1089 (1950) at 3 (commissioners court is trustee of permanent school fund; if commissioners
court abused its discretion by failing to invest fund for benefit of permanent school Rmd, order
would not be valid). As one court has stated,

           The county for which [the county commissioners] act holds the proceeds as
           an express trust, and the investment thereof in the securities named in the
           Constitution or otherwise, as may be prescribed by law, necessarily involves
           an exercise of judgment and discretion.


           [W]e see no reason why the county should not be held to the same rules of
           law that are applicable to other trustees.

Burks, 166 S.W. at 473-74 (emphasis added).

        Relying on the foregoing authority, this office has applied statutory provisions applicable to
trusts generally to county permanent school funds. See Tex. Att’y Gen. Op. No. M-l 104 (1972) at
2. Noting that under the Texas Trust Act a trustee could not sell property to the trust, this office
concluded that county commissioners could not sell to the county’s permanent school fund bonds
or other securities issued by the county while serving as trustees of the fund. Id. In addition,
reasoning that a trustee must “exercise the judgment and care under the circumstances then
prevailing, which men of ordinary prudence, discretion and intelligence exercise in the management
of their own affairs,” this office concluded that the proposed investment was also impermissible
because of the low interest rate on the securities to be purchased. Id. at 2-3. The opinion
emphasized that “great caution should be exercised [by the county commissioners court] to insure
that the highest prevailing rate of interest, consistent with investment safety, is secured on any
investment of county permanent school funds, and that said funds are invested in securities other
than those issued by the trustee-commissioners.” Id. at 3.

        “The ‘prudent’ character of an investment is ordinarily one of fact, unless reasonable minds
could not disagree.” Tex. Att’y Gen. Op. No. H-239 (1974) at 2. In one opinion, however, this
office concluded that courts would consider the investment of county permanent school fund
proceeds in low-interest bearing independent school district bonds imprudent as a matter of law. Id.

        Your letter states that although the “pass-through” mortgage-backed securities would yield
more than present county permanent school fund investments, the county would receive below
market rate for similar securities available in the market, explaining that the purpose of the program
“is to assist in providing housing to a segment of Webb County’s population that otherwise could
not afford it . . . Investment in the securities also will further the public purpose of providing low
The Honorable Judith Zaffirini - Page 3                  (JC-0004)




income housing in an area with an urgent need for such assistance.” We assume, based on your
description of the other similar securities as “comparable,” that the similar securities pose no greater
risk.

         Based on the facts you have provided, we believe that a court would very likely conclude that
the proposed investment is imprudent as a matter of law. First, it is doubtful that a prudent investor
would select the securities the county proposes to purchase on behalf of the permanent school fund,
given that other, similar securities available in the market would yield more at no greater risk.
Furthermore, although facilitating the provision of low-income housing pursuant to certain statutes
is a legitimate public purpose of the county,* the county’s duty of loyalty to the county permanent
school fund trust precludes it from pursuing this county purpose in investing permanent school fund
proceeds at the expense of the trust. Based on the information provided, we believe that a court
would conclude that the investments you describe are not consistent with the county’s
constitutionally-imposed fiduciary duty to the beneficiaries of the county permanent school fund.l




          ‘See TEX.LOCALGOV’TCODEANN.chs. 392, 394 (Vernon 1998 & Supp. 1999) (authorizing counties to
 establish housing authorities and housing finance corporations); see also TEX.GOV’TCODEANN.5 2256.024(c)
 (Vernon 1999)(permitting housing bond programs operatedby county housing authorities and county housing finance
 corporations to purchase mortgage pass-through certificates and individual mortgage loans). We do not address here
 whether a county may assist in providing low-income housing other than pursuant to these stahrtory provisions. See,
 e.g., Tex. Att’y Gen. Op. No. JM-942 (1988) at 3 (concluding that commissioners courts lack authority to guarantee
 loans for housing purposes).

          ‘Under the Texas Trust Code, a trustee who commits a breach of trust is chargeable with any damages arising
 from the breach of trust, including any profit that would have accrued to the bust if there had been no breach of tmst.
 See TEX.PROP.CODEANN.5 114,001(c)(3)(Vernon 1995).
The Honorable Judith Zaffirini - Page 4          (JC-0004)




                                      SUMMARY

              A county’s plan to invest county permanent school fund proceeds in
          “pass-through” mortgage-backed securities at an interest rate that is below
          market rate for similar securities available in the market in order to assist in
          providing low-income housing in the county is not consistent with the
          county’s trustee duties with respect to the fund under article VII, section 6 of
          the Texas Constitution.




                                              Attorney General of Texas

ANDY TAYLOR
First Assistant Attorney General

CLARK RENT ERVIN
Deputy Attorney General - General Counsel

ELIZABETH ROBINSON
Chair, Opinion Committee

Prepared by Mary R. Crouter
Assistant Attorney General
