Standardized investment agreements: a double-edged sword.

• Author: Dotson, Betsy

The magnitude of investment losses suffered by public and private entities alike in 1994 and 1995 as a result of speculative and often unsuitable derivative investments rocked the financial community and sent many legislators scurrying to introduce legislation to protect investors. Some of the proposed legislation made it through the legislative process and has become law, while voluntary initiatives surfaced as well. Now state and local governments are finding that efforts designed to protect them from unsuitable investment practices may be a double-edged sword.

Texas Statute Highlights Problems

The Texas Public Funds Investment Act, passed by the legislature in 1995, requires jurisdictions to have an investment policy and to provide it to any firm undertaking investment business with that entity. The act also requires broker/dealers doing business with a government to certify in writing that they have received and reviewed the government's investment policy and that they have implemented reasonable procedures and controls to preclude "imprudent" investment activities. In an effort to comply with this statute, industry representatives devised a standardized form that broker/dealer firms could use to do business with governments in the State of Texas. Submitted by a legislator to the state attorney general's office for its endorsement, the proposed standardized form was subsequently withdrawn from consideration.

The standardized form illustrates the potential problem governments face in trying to comply with statutes designed to protect public funds. This form went beyond the intent of the statute. The form included not only the required dealer certification but also a much broader "acknowledgment" by the investing entity, not called for by the statute. The acknowledgment stated that the dealer

1) is acting as a principal and at arm's length to the investor;

2) is neither an investment advisor nor a fiduciary to the investor; and

3) is not responsible for assuring compliance with those aspects of the investment policy over which the dealer has no control or knowledge, such as restrictions as to diversity and average maturity, or which require an interpretation of subjective investment standards.

Texas finance officers, in response to the submission of this standardized form, wrote to the attorney general proposing their own version of the form. In a letter signed by the president of the Government Finance Officers Association of Texas (GFOAT), the finance officers stated that they were "concerned about the content [of the standardized form] and the implications it might have for Texas governmental entities, other states, and federal legislation." The GFOAT version, which was sent to the attorney general as an acceptable substitute for the industry-sponsored form, would have continued to absolve broker/dealers of responsibility for aspects of the investment policy over which...