THE ATTORSEY GESERAL
OF TEXAS
Honorable 0. H. "Ike**Harris Opinion No. JR-975
Chairman
Economic Development Committee Re: Whether public funds
Texas State Senate may be invested in bank-
P. 0. Box 12068 oriented money market 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 Invest-
ment Act of 1987, now codified in Article
P
842a-2, Vernon's Annotated Texas Civil
Statutes (the 'Act'), in order to grant
public bodies an expansion of their invest-
ment authority. As a sponsor in the Senate
of the companion bill to H.B. 1488 and as
Chairman of the Committee on Economic Devel-
opment which heard and passed such bill, I
have received a number of inquiries from
representatives of public bodies and finan-
cial institutions as to the proper interpre-
tation 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
obligations described in the Act ('Eligible
Obligations'). (Emphasis in original.)
. . . .
In [Attorney General Opinion] JM-570, YOU
held that traditional money-market mutual
fund shares were not eligible for investment
of city funds (even though the funds were
restricted to holding federal securities)
because no Texas statute authorized such
P. 4960
Honorable 0. H. "Ike" Harris - Page 2 (JM-975)
investment. The question now is whether H.B.
1488 succeeded in overcoming #at statutory
deficiency if the mutual fund is an integral
part of a Texas bank's management and invest-
ment services. Accordinalv. vour oninion is
resnectfullv reauested as to whether a
bank-oriented monev market mutual fund of the
tvne described below constitutes a 'comnara-
ble investment device owned or administered
bv a bank domiciled in this State.' within
the meanina of the Act. such that a DubliC
bodv that otherwise comnlies with the re-
cuirements of the Act mav lawfullv invest its
bond nroceeds in such fund. (Emphasis
added.)
**Commontrust funds . . . administered,by banks" refers
to the classification of funds excluded from the definition
of "investment company" by the Federal Investment Company
Act of 3.940,referring to **anycommon trust fund or similar
fund maintained by a bank exclusively for the collective
investment and reinvestment of m‘oneyscontributed thereto by
the bank in its.capacity as a trustee, executor, administra-
tor,~or guardian." 15 U.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 investment companies in purpose
and mode of operation, and, without the ex-
ception in the 1940 Act, they would be reg-
ulated by the Act.
T. Frankel, 1 The Regulation of Money Managers, 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 dissolu-
tion of a common trust fund, the owners of units of partici-
pation will receive, pro rata, subject to the rights of
creditors, the proceeds of such sale less the liabilities of
the fund. As described, participation in such funds is
similar to the participation of shareholders in corporations
organized for private gain. In Presnall v. Stockyards Nat'1
Bank the court said:
It is generally agreed that shares in an
incorporated company are the aliguot parts of
P. 4961
Honorable 0. H. "Ike" Harris - Page 3 (JM-975)
the capital stock, and merely give to the
owner a right to his share of the profits of
the corporation while 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 winding up. 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 corpora-
tion. The right of the individual share-
holder, 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" con-
stitutes a "comparable investment device" within the meaning
of the public Funds Investment Act of 1987, and you draw
several parallels between the particular fund you describe
and a "common trust fund." If we assume the bank-oriented
money market mutual fund to be "a comparable investment
device," a question arises as to whether it is an "indivi-
dual, association or corporation" to which political corp-
orations and subdivisions are forbidden to lend credit or in
which they cannot become stockholders.
Article III, section 52(a), of the Texas Constitution
reads:
Sec. 52 (a) Except as otherwise provided
by this section, the Legislature shall have
no power to authorize any county, city, town
or other political corporation or subdivision
of the State to lend its credit or to grant
public money or thing of value in aid of, or
to any individual, association or 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 insurance policies and annuity con-
tracts issued by a mutual insurance company
authorized to do business in this State.
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Honorable 0. H. "Ike" Harris - Page 4 (JM-975)
None of the later-stated exceptions in section 52 embrace
loans to, or investments in, private enterprises or their
shares.
If nunits of participation" in a mutual fund are the
equivalent of shares of stock in a corporation, association
or company within the contemplation of article III, section
52, of the Texas Constitution, such investments cannot 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. A ss'n, 288
S.W. 409 (Tex. Comm'n App. 1926 judgment adopted), aff'd on
rehearinq, 294 S.W. 195 (1927).1
In Investment ComDanv Institute v. Camp, 401 U.S. 617
(19711, the United States Supreme Court considered the plan
of a national bank to go into the business of operating a
mutual investment fund. As described by the court:
Under the plan the bank customer tenders
between $10,000 and 5500,000 to the bank,
together with 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
issued which exnresses in 'units of nartici-
pation' the customer's DroDortionate interest
in fund assets. Units of participation are
freely redeemable, and transferable to anyone
who has executed a managing agency agreement
with the bank. The fund is registered as an
1. Monies paid to banks for such investment purposes
are not the equivalent of "deposits." In Lawson v. 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 funds on 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 reasoning with other jurisdictions that
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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Honorable 0. H. "Ike" Harris - Page 5 (JM-975)
investment company under the Investment
Company Act of 1940. The bank is the under-
writer of the fund's units of participation
within the meaning of that Act. The fund has
filed a registration statement pursuant to
the Securities Act of 1933. The fund is
supervised by a five-member committee elected
annually by the participants pursuant to the
Investment Company Act of 1940. The Securi-
ties and Exchange Commission has exempted the
fund from the Investment Company Act to the
extent that a majority of this committee may
be affiliated with the bank, and it is
expected that a majority always will be offi-
cers in the bank's trust and investment
division. The actual custody and investment
of fund assets is carried out by the bank as
investment advisor pursuant to a management
agreement. (Emphasis added.)
401 U.S. 617, at 622-623.
A federal law provided that a national bank "shall not
underwrite any issue of securities or stock.tl 12 U.S.C.
§ 24. After observing that a bank which operates an invest-
ment fund has a particular investment to sell, the court
held that the operation of the investment fund involved a
bank in the underwriting, issuing, selling and 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 com-
w. The Investment Company Act of 1940
defines an investment company as an 'issuer'
of 'any security' which 'is or holds itself
out as being engaged primarily in
the business of investing . . . in' securi-
* '
ties .' 15 U.S.C. 55 80a-2(a)(21),
80a-3 (i)'(i). An open-end company is one
'which is offering for sale or has out-
standing any redeemable security of which it
is the issuer.' 15 U.S.C. 5 80a-5(a)(l). An
investment comnanv also includes a \unit
investment trust': an investment comoany
which. among other thinas. 'is oraanized
under a . . . contract of . . . aaencv . .
and . . . issues only redeemable securities:
each of which renresents an .undivided
P. 4964
Honorable 0. H. *Ike" Harris - Page 6 (JM-975)
?
interest in a unit of snecified securities
.' 15 U.S.C. 5 80a-4(2). (Emphasis
Added.)
&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 fairly used as a description,
also, of a share of stock. m Presnall v. Stockvards Nat'1
&&, sutxq. Section 52 of article III of the Texas Consti-
tution prevents a county, city or other municipal corpora-
tion from becoming Ita stockholderl' in a "corporation,
association or company." It has been suggested, however,
that units of participation in bank-oriented money market
mutual funds are not the functional equivalents of shares of
stock in a profit-seeking enterprise, and that holders of
certificates evidencing ownership of such participatory
interests would not be V1stockholdersV*
within the meaning of
the constitution.
The argument suggests that units of participation in a
portfolio consisting of governmental obligations are not
equivalent to shares of stock within the constitutional
prohibition because they are not shares of bank stock, they
are not interests in a portfolio of securities consistinq of
stock in a private corporation, association or company, and
the fund itself is not a corporation. However, it must be
admitted that such funds, though not organized as corpora-
tions, are private enterprises operated for profit or gain,
that money invested in such an enterprise is put at risk in
a common venture, that the securities in the portfolio of
the fund (whether consisting of stocks of private corpora-
tions or of government bonds) are merely the assets of the
fund and not themselves the enterprise, and that return on
the investment depends upon how those assets are~~used by
fund managers.
In Attorney General Opinion JM-570 (1986), to which
you refer, we advised that money market mutual funds,
including those that deal only in government securities, are
private enterprises operated for private gain. We also
said:
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
P. 4965
Honorable 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 fund or its dispo-
sition, and has no right to reduce to posses-
sion any part of it for safekeeping or 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, accountability and expertise of the fund
managers as well as the financial stability and responsibil-
ity of the entities whose obligations are represented in the
portfolio of the fund. Cf. Attorney General Opinion JM-23
(1983) (repurchase agreements).
Although we concluded in Attorney General Opinion
JM-570 (1986) that statutes advanced there by proponents to
support investment of public funds in the securities (in-
of private entities did not
cluding participatory **units@')
provide that support, we did not suggest that statutes
purporting to do so, if enacted, would face no constitu-
tional hurdles. Attorney General Opinions x4-932
(1988): JM-832 (198F; JM-545 (1986); JM-23 (1983)' -
(1980) (constitutional issue not addressed). The ente$iii
represented by a mutual fund such as you describe is one of
individuals or entities associated for the purpose of
private gain. Although the fund is not incorporated, it is
an "association" or "company" within the meaning of the
Texas Constitution. Mills v. State, 23 Tex. 295 (1859).
In Mills v. State, m, the Texas Supreme Court had
occasion to examine a provision of the 1845 Texas Constitu-
tion that provided, "No cornorate bodv shall hereafter be
created, renewed, or extended, with banking or discounting
privileges." (Emphasis added.) Tex. Const., art. VII, 5 30
(1845). In 1840, the legislature enacted a law declaring
"[t]hat any Cornoration. Comnanv. or Asssociation of
individuals who shall use or exercise banking or discounting
privileges in this State, . . . shall be deemed guilty."
(Emphasis added.) 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 illegal banking, 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 indivi-
duals. was a violation of the snirit of the
P. 4966
Honorable 0. H. "Ike" Harris - Page 0 (JM-975)
constitution, iust as much 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 acting together for the prosecution
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 prosecution of important enterprises. Id.
at 303-304.
Scarcely fifteen years later, using words given meaning
by the Mills court, section 52 of article III of the 1876
Constitution was written to deprive the legislature of power
to authorize any political subdivision to become a "stock-
holder" in a *'corporation,association or company." In that
era, nstock'*broadly referred to the capital of an enter-
prise. The 1859 edition of Bouvier's Law Dictionary defined
"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 corpora-
tions is also called stock: this is usually
divided into shares of a definite value, as
one hundred dollars, fifty dollars per share.
2 Bouvier's Law Dictionary (8th ed. 1859), at 550.
In the light of Mills v. State, the reference placed in
the new constitution to ustockholders'Oin associations -and
companies (as well as to stockholders in corporations),
exhibited a plain determination that its prohibition should
reach participation in non-corporate, private enterprises of
aggregated capital. That is the construction given the
provision by the Texas courts. Lewis v. Indenendent School
District of Austin, sunrq; WcCaleb v. 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, Lewis v. Indenendent School District
of Austin m, was decided by the Supreme Court of
Texas in i942 before the current final sentence was added to
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Honorable 0. H. *'Ike"Harris - Page 9 (JM-975)
article III, section 52(a) by amendment (November 4, 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, in Middleton v. Texas
Power & Liaht Co., 185 S.W. 556 (Tex. 1916), said that the
Texas Employers Insurance Association (legislatively created
in conjunction with the enactment of the Workmens' Compensa-
tion Law) was not a private corporation but, instead, was
only an agency for proper administration of the law notwith-
standing its designation by the legislature as a "corpora-
tion." 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 permitting political subdi-
visions to become members of the association. The court
said the organization was 'a corporation engaged in the
insurance business 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 "becoming stockholders therein." Id.
On rehearing, the Commission of Appeals denied that it
had overruled the Middleton case. The court said the point
in the Middleton case was that the association was not a
corporation within the meaning of the general law authoriz-
ing corporations, but that it did not follow that the
association did not have elements of a private corporation,
concluding:
We have merely indicated ours opinion that the
nature of such association, whether 'techni-
callv a cornoration or not,' is such that
municipal corporations cannot become sub-
scribers thereto without violating constitu-
tional limitations. (Emphasis added.)
CitV of Tvler v. 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. 4968
Honorable 0. H. aIke*'Harris - Page 10 (JM-975)
[T]he Legislature is without power (section
52, art. 3, Constitution) to authorize a
municipal corporation of the kind involved~to
become, in effect, a 'stockholder' in the
Texas Employers' Insurance Association (sub-
stantially a 'mutual‘ company), and thus to
'lend its credit,' etc., or to make the 'ap-
propriation of public money' (held to be a
gratuity) necessary to affecting insurance.
(Emphasis added.)
12 S.W.Zd 200. Later still, the Texas Supreme Court ex-
plained the Citv of Tvler holding. The court said in
McCaleb v. Continental Casualty Co:
It was also held that by virtue of section 52
of article 3 of our Constitution, Vernon's
Ann. St. Const. art. 3, 5 52, municipal
corporations could not take out a policy of
insurance in a mutual insurance-company which
would require a city to become a member of or
stockholder in such insurance company.
(Emphasis added.)
116 S.W.2d 679, 680 (Tex. 1938).
Nevertheless, when the Lewis case came before the Court
of Civil Appeals in 1941, the intermediate court was per-
suaded that the Citv of Tvler and Southern Casualty Co.
holdings were merely "obiter" to be dismissed as not con-
trolling. Lewis v. Indenendent School 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
school district in the Lewis case made ~g loan of its credit
to the mutual insurance company from which it purchased
workmen*9 compensation coverage, that the school district
did nnf;become a stockholder in the insurance company or a
subscriber to its capital stock by its purchase of the
insurance policy, and it quoted from a North Carolina case
to the effect that a YstockholdeY is the owner of shares in
a corporation having capital stock represented by shares,
and that a mutual company is without "stock" or "stockhold-
ers" . && at 302.
When the Lewis case reached the Texas Supreme Court,
the court characterized the question as whether the legisla-
ture could constitutionally authorize the school district, a
political corporation, to purchase a policy of mutual insur-
ance. 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 nro-
hibits the School District from becomina a
stockholder in a corooration, association. or
comnanv. Whether the public policy announced
in the Constitution is wise 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 point we might all agree, but expe-
diency cannot substitute the 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, the matter is indelibly settled, and
its wisdom cannot be 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 functional equivalents of
shares of stock within the 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 munici-
palities 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 sentence to the general prohibition:
However, this section does not prohibit the
use of public funds or credit for the payment
P. 4970
Honorable 0. H. "Ike" Harris - Page 12 (JM-975)
of premiums on nonassessable life, health or
accident insurance policies and annuity
contracts issued by a mutual insurance
company authorized 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 otherwise alter the
scope of the constitutional prohibition, and we believe it
continues to prohibit the investment of public funds in
other private enterprises of aggregated capital, whatever
might be their nomenclature.
In recent years, the courts of other states have ac-
corded a similar reading 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 Trustees of the P;blic
EmDlOVees' Retirement Fund of Indiana v. Pearson, 459 N.E.2d
715 (Ind. 1984); Public Housina Administration v. Housinq
Authoritv of Boaalusa, 137 So.Zd 315 (La. 1961). a.
Louisiana State EmDlOVeSS’ Retirement Svstem v. State, 423
So.2d 73 (La. Ct. App. - [let Cir.] 1982), writ denied, 427
So.2d 1206 (1983). ,~. I
In our opinion, insofar as the Public Funds Investment
Act of 1987 (article 842a-2, V.T.C.S.) purports to authorize
political corporations and political subdivisions to invest
public funds in bank-oriented money market mutual funds or
securities of private entities, it conflicts with the con-
stitutional provision.
SUMMARY
Insofar as article 842a-2, the Public
Funds Investment Act of 1987, purports to
authorize political corporations and politi-
cal subdivisions to invest public funds in
bank-oriented money market mutual funds or
other securities of private entities, it
conflicts with article III, section 52, of
the Texas Constitution.
Attorney General of Texas ?
P- 4971
i.
Honorable 0. H. "Ike" Harris - Page 13 (JM-975)
MARY KELLER
First Assistant Attorney General
mu MCCREARY
Executive Assistant Attorney General
JUDGE ZOLLIE STEAKLEY
Special Assistant Attorney General
RICK GILPIN
Chairman, Opinion Committee
Prepared by Bruce Youngblood
Assistant Attorney General
P. 4972