Investment Authority of Cities of the Primary Class to Make De Minimus Investments in Federally Regulated Funds and Securities Under Applicable State Law

@ttiw of tISe glttomey Genersl STATE OF NEBRASKA 2115 STATE CAPITOL BUILDING LtNCOLN, NE 68509-8920 (402) 471-2682 TDD (402) 471-2682 cAP|TOL FAX (402) 471-3297 TTERONE FAX (402) 471-4725 JON BRUNING ATTORNEY GENERAL SUBJECT lnvestmentAuthority of cities of the primary class to Make De Minimus lnvestments in Federally Regulated Funds and securities Under Applicable State Law REQUESTED BY: Senator Chris Beufler Nebraska State Legislature WRITTEN BY Jon Bruning, Attorney General Fredrick F. Neid, Assistant Attorney General This is in response toyourrequestforan opinion of this Office relatingtothe investment authority of cities of the primary class for purposes of investing in equiiy securities. The specific question you ask is "whether LB 186 is consistent with thL Nebiaska Constitution to the extent it would permit subdivisions of the state to make de minimus investments in federally regulated funds and securities under applicable state investment guidelines.,, The legal issue framed by your question is whether the LB 1 86 amendments to Neb. Rev. stat. $ 15-849 (Cum. Supp. 2004) would constitutionally permit investment of city funds in capitj stock and other securities of private corporations or associations. It is our opinion that the amendatory provisions of LB 186 would not serve to constitutionally authorize nor permit cities of the primary class, subdivisions of the state, to invest city funds in equities, capital stock or other securities of private corporations or associations. Due to the constitutional prohibition of such investments, we believe that amendment of Art. Xl, S 1 of the Nebraska Constitution would be necessary to obtain explicit OF NEBRASIG Flcll\L IIAR E M5 Pdntod wlth soy ink on rccycled papar Chris Beutler March 3, 2005 Page -2- constitutionalauthorityforbroaderinvestmentof surplusfunds of cities of the primaryclass or other subdivisions of the state. BACKGROUND The question you ask is fact specific and we have based our analysis on the information included in the request letterof January 24,2005. Forpurposes of legalanalysis, itiscriticaltoknowthenatureofthefundsavailableforinvestment. Thatis,whetherthefunds to be invested are private or public funds. The constitutional limitation has been held not to apply to purely private funds managed by the state in other jurisdictions having similar constitutionallimitations. An example of private funds are college tuition payment programs permitting families to make advance purchases of tuition for students in future years or similar programs. For purposes of this opinion, the funds for investment are considered to be public funds owned by the city or other government subdivision. We also polnt out that the Nebraska Constitution establishes broad investment authority for funds of city, police, or fire pension or retirement plans. Article XV, S 17(2) provides that the Legislature may authorize the investment of retirement or pension funds in such manner and in investments as the governing body of the city orpoliticalsubdivision may determine subject to limits provided by statute. Briefly described, LB 186 would expand the investment authority of cities of the primary' class to invest funds in (1) securities of the United States, the State of Nebraska, a city of the primary class, a county in which such city of the primary class is located, or a school district of such city, (2) securities of municipally owned and operated public utility propefi and plants, or (3) such securities in which the state investment officer is authorized to invest pursuant to the Nebraska Capital Expansion Act and the Nebraska State Funds lnvestmentAct and as provided in the authorized guidelines of the Nebraska lnvestment Council in effect on the date the investment is made.1 Section 15-849 currently limits investment by the city treasurerto purchases of certificates of deposit of banks, capital stock financial institutions, orqualifying mutual financia! institutions selecteC as depositories of ci$ funds. Other provisions establish bond requirements forsafekeeping and payment of deposit amounts. See Neb. Rev. Stat. S 15-845 to 15-848 (Cum. Supp. 2A0q. lThe amendments of LB 1 86 do not serve to expand the investment authority of cities of the primary class because cities of the primary class and othersubdivisions of the state, except school districts, already possess the investment authority provided by the LB 186 amendments. See Neb. Rev. Stat. 577-2341 (2003). Chris Beutler March 3, 2005 Page -3- STATUTORY PROVISIONS AND INVESTMENT GUIDELINES It is generally established that municipalities hold and exercise their powers subject to legislative control and the legislative authority overthe civil, political, and governmental power of municipal corporations is limited by the Federal and State Constitutions. The fiscal and investment authority of state subdivisions is reposed in statute. Neb. Rev. Stat. g 15-845 (Cum. Supp. 2004) requires the treasurer of a city of the primary class to deposit, ind at all times keep on deposit in financial institutions, all money received or held by the treasurer. Neb. Rev. Stat. $ 15-849 (Cum. Supp. 2004) authorizes the treasurerto purcl.rase certificates of deposit and make time deposits in financial institutions. Other provisions afford broader investment authority for state subdivisions. Neb. Rev. Stat. $ 77-2341(2003) authorizes cities and othergovernmentalsubdivisions, except school districts, to invest its surplus funds in any securities in which the state investment officer is authorized to invest in.2 sectionTT-2341in relevant part states: (1) Wheneveranycounty, city, village, orothergovernmentalsubdivision, other than a school district, of the State of Nebraska has accumulated a surplus of any fund in excess of its current needs... the governing body of such county, city, village, orothergovernmentalsubdivision may investanysuch surplus in excess of current needs... in certificates of deposit, in time deposits, and in any securities in which the state investmentofficeris authorized to invest pursuant to the Nebraska capital Expansion Act and the Nebraska State Funds lnvestmentAct and as provided in the authorized investment guidelines of the Nebraska lnvestment Council in effect on the date the investment is made. The state i nvestment offi cer shall u pon request fu rn ish a copy of cu rrent a utho rized investment guidelines of the Nebraska lnvestment Council. The State lnvestment Officer has broad investment authority subject to the "prudent man standard" underthe direction of the Nebraska lnvestment Council. Neb. Rev. Stat. $ 72-1246 (2003) in particular part states that "[t]he state investment officer shall invest in investments of the nature which individuals of prudence, discretion, and intelligence acquire or retain in dealingwiththepropertyofanother..." Forpurposesofprovidingdirectionandguidelinesfor investment of funds by the State lnvestment Officeras wellas for politicalsubdivisions, the Nebraska lnvestment Council has adopted strategies set forth in lnvestment policy Statements. Various policy statements are in place fordifferent categories of funds available for investment by the State lnvestment Officer. For example, policy statements have been 2similarauthority is included forcities of the metropolitan class in Neb. Rev. Stat. S 14- 563 (Cum. Supp. 2004). ehris Beutler March 3, 2005 Page -4- adopted thatestablish specific investmentguidelinesforeach of the retirementplans under the administration of the Public Employees Retirement Board and for other state funds including the Operating lnvestment Pool and the Health Care Endowment Fund. lmportantly, the Nebraska lnvestment Council has adopted a policy applicable to governmental subdivisions, N EBRASI(A I NVESTM ENT COU NCI L POLICY FOR POLITICAL SUBDIVISIONS. The policy statement includes the following recitals: The State of Nebraska Constitution explicitly prohibits subscription to stock by political subdivisions in Article Xl. The statutes of the Legislature and significantprecedentfrom State courtdecisions provide a distinction between the retirementfunds of a politicalsubdivision and the non-retirementfunds of a political subdivision. The activity of the Legislature and the court sysfem leads to the situation that the retirement funds of political subdivisions can own stock and the non-retirementfunds of political subdivisions cannot Thus, this policy distinguishes between retirement funds and non-retirement funds NEBRASKA INVESTM COUNCIL POLICY FOR POLITICAL SUBDIVISIONS, at 1, adopted January 28,2003, amended September 27,2004. (emphasis added) Accordingly, the investment guidelines of the state investment officer set forth in the policy statement applicable io politicalsubdivisions do notsei"ve to authorize investment by government subdivisions in equity or other interests of private corporations or associations. CONSTITUTIONAL LIM ITATIONS The constitutional prohibition regarding ownership of stock applicable to governmental subdivisions of the State is set forth in Art. Xl, $ 1 of the Nebraska Constitution which states: No city, county, town, precinct, municipality, or other subdivision of the estate, ehall arrarlraaamaaorrl-o^tiharaf thaaanitral alaalz ^f ^.r^h a(aal. ^- o! lclll svEl vsvLrr I ls Cl -tLtlJit\rl llr(tM Ll lg tJclyllcll OL(.,IJI\, \,l \rYYl lEl \i,l lUUl I Dt\,Unr Ua any portion or interest therein of any railroad, or private corporation, or association. The prohibition has been applied by the Nebraska Supreme Court to preclude investment by state subdivisions in stock or other ownership interests of private corporations or associations. ln Nebraska League of Savings and Loan Assns. v. Mathes,201Neb.122, 266 N.W.2 d720 (1978), the Court considered whetherthe constitutional limitation prohibited politicalsubdivisions from depositing funds in mutualsavings and loan associations. The Court concluded that the constitutional provision barred the deposit of funds by subdivisions of the State of Nebraska in mutual savings and loan associations, whether federal or state Chris Beutler March 3, 2005 Page -5- chartered, except those funds authorized underArt. xv, s 17 (2)of the Nebraska constitution ln reaching this conclusion, the Court reasoned: The historical background warrants the conclusion that the constitutional provision was directed against the acquisition by a subdivision of the state of any ownership or proprietary interest in a private corporation orassociation... ld. at 129,266 N.W.2d at724. The holding of the Nebraska Supreme Court in Nebras ka League of Savings and Loan Assns. is consistent with decisions in other jurisdictions having similar constitutional limitations' See Michigan Savrngs & Loan League v. Municipat Finance Commission of th9 State of Michigan,247 Mich. 311,79 N.W.2d 590 (1956) (statute authorizing investment of schooldistrictfunds in building and loan orsavings and loan associations is invalid under constitutional prohibitions of subscription to corporate stock). lnWest VirginiaSfafe v. West virginia Board of lnvestments, 194 w. va. 143,459 s.E.2d 531 (1gg5), the supreme court of Appeals of WestVirginia found thattrustfunds in a consolidated pension fund representing money of Public Employees Retirement System were state funds subjectto the constitutiona-l prohibition on state ownership of corporate stocks. ln West Virginia Sfafe, the state constitution provided that the State shall not become a joint owner-or stockholder in any company or association in the state or elsewhere. The West Virginia Court stated: The clear language of Article X, section six itself stands as a bar to state ownership of corporate stocks. This result is compelled by virtue of the fact that Article X, section six is written as an unconditional proscription of the State's investment in stock of any company or association. ld. at 149, 459 S.E.2d at S3Z. The Court of Appeals of Oregon ,in ICMA Retirement Corp. v. Executive Department, 92 Or' App. 1 88,757 P.2d 868, review denied,306 Or. 661 , 763 p.2d 152 (1gggi, held the constitutional prohibition against state's purchase of corporate stock barred investment of employees' deferred compensation in a trust plan. The courts reasoned that the state would have a proprietary orownership interest in the deferred compensation money thatwould be invested in the trust plan and thereby barred.3 3ln lcMA Retirement corp., it was argued that the state, even if technically the beneficial ownerof the fund, may transferthe fund to a trustee to invest in corporate stocks. The Court disagreed and stated, "That argument ignores the basic requirement that the state cannot purchase stock with money it owns, which is precisely what it would do here." ld. 92 Or. App. 193,757 P.2d 871. Chris Beutler March 3, 2005 Page -6- However, the cases reach the opposite conclusion if it is determined that the funds for investment are not owned by the government orthe governmentalentity has no proprietary interest in the funds. ln Sprague v. Staub, 205 Or. 507 , 451 P.2d 49 (1969), the Supreme Courtof Oregon held thatan industrialaccidentcommission fund and employees'retirement fund were trustfunds which state treasurer held only as custodian and the state had no interest in the fundsthatwould prohibitfundsfrom being invested in stockof corporation pursuantto statutory authorization. ln reaching this conclusion the Court stated: We are of the opinion that the people intended the prohibition in Article Xl, S 6 to apply only to funds owned by the state and not to funds which the state has expended and forwhich the state has received a quid pro quo, as itdoes, when it receives coverage for its employees through its contributions as employers to these funds. ld. at 524,451 P.2d at 58. Thus, a distinction is made by the courts with respect to whether the funds for investment are public funds, that is, owned by the governmental subdivision. lf the funds are private orthe governmental subdivision has no proprietary interest, the courts generally have eoneiuded that the constitutional iimitation does not apply. PUBLIC PURPOSE OR USE It is long established in Nebraska and in other jurisdictions that the constitutional prohibitions regarding subscription to or purchase of capital stock of private corporations were not intended to preventgovernmentalsubdivisionsfrom acquiring propefiforpublic use. ln Sfafe ex rel. Johnson v. Consumers Public Power District,143 Neb. 753, 10 N.W.2d 784 (1943), the Nebraska Supreme Court concluded that a subdivision may acquire stock to aequire physicai properiy for a defined pubiic purpose ancj staied: This provision of our Constitution must be construed with reference to the evils it was intended to correct or prevent. lt was intended to prohibit any subdivision of the sfafe from entering inta private busrness by being assoclafed as a stockholder, or by being a partner, or a part owner, in a private business venture orenterprise... Section 1 , Article Xl of our constitution was never intended to prohibit a purchase by a subdivision of the state of allthe capital stock of a corporation solely for the purpose of lavufully acquiring the Chris Beutler March 3, 2005 Page -7- physical property of such corporation fora public use, constitutionally defined and laMully authorized by the legislature. ld. at766,767, 10 N.W.2d at7g4. (emphasis added). The LB 1 86 amendments do not purporl to authorize the purchase of stock to enable a city of the primary class to acquire physicalproperty fora defined public purpose. Rather, the amendments would broaden the authority of cities to invest in equities and thereby become a stockholder or part owner in a private business enterprise. we believe the LB 1 g6 amendments would be narrowly construed by a court to preclude such investments in private entities consistent with the constitutional limitation set forth in Art. Xl, S 1. OTHER AUTHORITIES This office previously addressed the question whetherthe surplus funds of a county hospital may be invested in mutual funds comprised of U.S. Government Securities and obligations' ln Neb. Op. Att'y Gen. No. 95041 (May 17, 1995) we concluded that it was generally permissible for a county to invest surplus funds in mutual funds comprised solely of U.S. Government obligations but, that the organization and prospectus of the investment companywould have to be carefully examined to insure thatthe poiiticalsubdivision was not acquiring an'interest in the investment company. In the opinion, we commented, ,,[t]he Con_stitution's language certainly prohibits a county from investing in a mutualfund when the portfolio includes stock, but it does not specifically address the issue of mutual funds solely comprised of U'S. Government Obligations." td. at 3. lt was also concluded that an amendment to Art' Xl, S 1 specifying that investment in management investment portfolios limited to U.S. Government securities would be required to remove the uncertainty due to the constitutional basis for the potential prohibition of such investments. Other states' Attorneys General have addressed similar issues. An opinion of the Louisiana Attorney General concluded that Louisiana statutes allowing excess funds of politicalsubdivisions to be invested in money market mutualfunds *ere-unconstitutional.a See 88 La' Op. Att'y Gen. No. 546 (1 988) And, an opinion of the Arkansas Attorney General considered the question whetherthe Department of Corrections can purchase membership in a "cotton gin cooperative"which is capitalized with common stock. The Departmentwould become a shareholder by buying stock in the cooperative and become a voting member. aArticle vll, s 14 of the Louisiana constitution includes similar language to Art. xl, s 1 of the Nebraska Constitution. The Louisiana Constitution provision states-in part,,,Neitherthe state nor a political subdivision of a state shall subscribe to or purchase the stock of a corporation or association..." Chris Beutler March 3, 2005 Page -8- Arkansas Constitution, Art. 12, S 7 provided, "...the State shallneverbecome a stockholder, or subscribe to, or be interested in, the stock of any corporation or association." The ArkansasAttorney General concluded that, "...underthe plain language of ourconstitution, that the Depaftment's purchase of the stock in the association would therefore be unconstitutional." Ark. Op. Att'y Gen. No. 95-035 (February 21, 1995). The Washington Attorney General has had occasion to thoroughly analyze and considerthe issuewhetheritis consistentwith the state constitution forthe state investment board to use its statutory authority to purchase stocks and other corporate equities as part of its investment of funds in the advanced college tuition account. The Attorney General of Washington concluded thatthe state constitution limits the state with regard to the investment of state funds butthe limitations have not been held to apply to purely private funds managed by the state. See Wash. Op. Att'y Gen. No. 05 (July 5, 2000). ln so concluding, the opinion stated: The first question is whether the funds to be invested in connection with the advanced college tuition program are public or private funds. lf public funds are involved, the plain language of the constitutionalprovisions cited appears to prohibit the investment of such funds in corporate stocks or similar equities, sincethe resultwillquite clearlygivethestate an interestin thestocks of private corporations. ld. at4. Lastly, the Washington Attorney General observed: We took a cautious view in AGO 1984 No. 22, suggesting that a further constitutional amendmentwas the safestway to establish broader investment authority for industrial insurance funds. (footnote omitted). Past legislatures have elarified their authority by obtaining expiicit eonstitutionai authoriiy for broader investment of pension funds and industrial insurance funds. (footnote omitted). A similar amendment would remove all doubt with regard to the investment of the advanced college tuition program, but may prove to be unnecessary if the courts agree with this analysis. /d at6 Chris Beutler March 3, 2005 Page -9- We have also reviewed the opinion of the Colorado Attorney Generalyou referenced in your request letter. In Col. Op. Att'y Gen. No. OAG 8600818 (March 10, 1g86) the questionswhetherexisting provisions of Colorado constitutionaland statutory lawauthorize the state treasurerto invest funds in a real limited partnership were addressed. The Attorney General concluded that present statutes do not authorize such investments and that the application of relevant constitutional provisions would depend upon whether the statutory scheme serves a sufficient public purpose. ln summary, the opinion stated, "lam unable at this time to form an opinion whether future legislation authorizing an investment would be constitutional. In order to satisfy constitutional restrictions, such legislation would have to narrowly demonstrate a discrete and particularized public purposewhich would preponderate over any private interests incidentally served." ld. at6. We think the Colorado opinion is of limited assistance since it concluded that the proposed investments would exceed existing statutory authority and a conclusive opinion was not rendered concerning whether the constitutional provisions precluded the General Assembly from enacting legislation authorizing investment of public funds in a limited partnership. The predominantviewof the states attorneys generalis that investmentof publicfunds in capitalstock orotherequity interests of private businesses is violative of state constitutional limitations; except in circumstances where the acquisition of stock or other ownership interests is necessary to acquire property for a public use or purpose. And, it is the consensus view that constitutional amendment is necessary to remove any question of application of the constitutional prohibition, even where the funds to be invested by the government subdivisions are private. DE MINIMUS INVESTMENTS Your question has been posed in the context of a government subdivision making "de minimus" investments in federally regulated funds and securities under applicable state investment guidelines. lnformation included in your request letter reflect that de minimus investments are those comprising "no more than 1 o/o ot2o/o" of a particularentity's securities. We have found no case or other authority that has analyzed or decided the constitutional issue based on the percentage of ownership of the outstanding stock or capital of a private company purchased for investment. We point out, however, that the constitutional prohibition is not aimed at control of a private concern but ratherparticipating as an owner. The Nebraska Supreme Court's holding in Sfafe ex relJohnson v. Consumers Public Power Districtreflects the view that purchase of a majority if not allof the capitalstockof a private companyto acquire physicalpropertyfor public use does notfallwithin the constitutionalprohibition. Thus, this line of authoritysuggests Chris Beutler March 3, 2005 Page -1 0- that purchases of lesser stock holdings, not for the purpose of acquiring physical property for public use, but ratherfor investmentwould be violative of the constitutional prohibition barring a government subdivision from being associated with a private company as a shareholder SUMMARY The case law and other authorities generally concur that government subdivisions are precluded from investing in corporate stocks and equities of private companies and associations underconstitutionallimitations prohibiting such ownership. Forthe most part, the courts have held that such constitutional limitations are not applicable to private funds or fundsnotownedbythegovernmentalsubdivision. Thequestionwhetherthespecificfunds available for investment are public or private is complex and the courts may diverge on this issue. Forthese reasons, it is ouropinion thatthe LB 186 amendments are not consistentwith the Nebraska Constitution to the extent itwould permit subdivisions of the State to invest in stocks and bonds of private companies, associations, or corporations. We believe explicit constitutional authority is necessary for broader investment of surplus public funds of state subdivisions in capital stock and otherequity ownership interests in private corporations and associations. Sincerely, JON BRUNING Attorney General redrick F. Ne Assistant General ,APPR,OT/ED: ey General 21-152-24