Protecting public funds demands constant alertness.

• Author: Esser, Jeffrey L.
• Position: Editorial

Public investors have been heartened recently by three events that continue to emphasize the importance of suitability as a primary concern in the investment of public funds: the elimination of an onerous suitability provision from proposed federal legislation, final Securities and Exchange Commission (SEC) approval of a suitability rule, and the withdrawal of a proposed standardized investment form in the State of Texas. These events are pivotal in the ongoing debate over the degree of responsibility broker-dealers owe to state and local government investors and their taxpayers when making investment recommendations. Despite these positive developments, however, state and local government investors are urged to continue to be vigilant for new attempts to weaken or eliminate suitability protections.

In the area of federal legislation, state and local governments and their pension funds were gratified when a proposal that would have weakened existing suitability requirements was deleted from a securities bill before it was approved by the House Subcommittee on Telecommunications and Finance. (No similar provision had been included in companion Senate legislation.) The provision that was removed defined an institutional investor as one with a portfolio of at least $10 million and protected broker-dealers from any liability for the investment decisions of institutional investors unless a written agreement stating otherwise was in effect. The written agreement would have been the only means by which a broker-dealer could have been held liable. After strong criticism by GFOA members and other state and local government officials and concern that the inclusion of such a provision could defeat the rest of the bill, members of the House subcommittee agreed to delete this harsh provision from the legislation.

If that suitability provision had been passed, it would have effectively repealed a key portion of the Government Securities Act Amendments of 1993. That law authorized sales practice rules, including those governing suitability, to be written by the National Association of Securities Dealers, Inc., (NASD) and financial institution regulators. NASD's suitability rule calls for broker-dealers to determine their institutional customer's ability to evaluate investment risk independently and whether their customer is exercising independent investment judgment by considering a number of nonexclusive factors. To become effective, the NASD rule...