Could Idaho's endowment fund managers earn extra income by lending out the state's stocks and bonds, or by selling 'covered call' options on those securities?
Plain-English summary
The Chairman of the Idaho Endowment Fund Investment Board asked the Attorney General three questions about modern investment techniques: securities lending, covered call options, and the accounting treatment for option premium income.
The constitutional gate was Idaho Const. art. 9, § 11, which provided that "[t]he permanent endowment funds . . . shall be loaned on United States, state, county, city, village, or school district bonds or state warrants or on such other investments as may be permitted by law under such regulations as the legislature may provide." The Idaho Supreme Court in Engelking v. Investment Board (1969) read "loan" strictly: it required "a guarantee of full repayment of principal as well as interest" and "an unconditional promise to repay the principal sum originally lent." That ruling had constrained Idaho endowment investments for nearly two decades.
Securities lending. In a securities lending arrangement, the owner lends the security to a borrower who agrees to return it plus any interest or dividends paid during the borrowing, plus an additional premium for the right to borrow. The borrower's repayment obligation is unconditional. Custodian banks often indemnify customers against loss. The AG concluded these transactions are consistent with the "loan" limitation under Engelking, because they include "a guarantee of full repayment of principal as well as interest." Idaho Code § 57-722 did not yet authorize securities lending, so legislative amendment was needed. The constitutional path was clear.
Covered call options. A covered call is an agreement where the option seller (the endowment) owns securities and grants the buyer the right to purchase them at a fixed price by a certain date, in exchange for a premium. The seller profits if the option goes unexercised; the buyer profits if the price rises above the strike. The AG concluded covered calls would not violate the "loaned" requirement of art. 9, § 11. Endowment funds remained loaned on the underlying bonds; the option simply established acceptable terms of sale during the option period. The AG drew an analogy to call provisions in bonds themselves: a 20-year bond with a 10-year call provision is still a loan under Engelking, because exercise of the call repays the principal in full. The same reasoning applied to selling a covered call.
Two cautions. First, the AG advised that calls should not be sold at exercise prices below the principal sum originally lent. If the strike plus premium would not repay the principal, the transaction would not satisfy Engelking's "unconditional promise to repay the principal sum originally lent." The AG acknowledged a counter-argument from State ex rel. Moon v. State Board of Examiners (1983), where the Idaho Supreme Court approved selling investments at a loss for portfolio-flexibility reasons, but reasoned that courts could view covered calls as agreements modifying the original loan terms (rather than as separate sales) and so apply the strict Engelking repayment requirement. Second, speculation in covered calls is not a permissible use; the Board's fiduciary duty constrains the use of options to portfolio-management purposes consistent with the conservative-investment posture of an endowment.
Accounting. The AG concluded that premium income from selling covered call options should be accounted for as securities gains, not as income to be distributed under Idaho Code § 57-724. The premium is consideration for granting the option, which is part of managing the underlying security position rather than income generated by the security itself.
Currency note
This opinion was issued in 1988. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.
Background and statutory framework
Idaho's endowment fund (originally state lands granted at statehood, plus accumulated investment earnings) is governed by Idaho Const. art. 9, § 11, which restricts the legislature to authorizing "loans" rather than the broader category of "investments." That linguistic choice was deliberate, and the Idaho Supreme Court took it seriously in Engelking v. Investment Board, 93 Idaho 217 (1969). Engelking invalidated portions of a 1969 statute that would have permitted purchase of stock and conversion of bonds, holding that those transactions did not satisfy the "loan" requirement because they did not include "a guarantee of full repayment of principal as well as interest" or "an unconditional promise to repay the principal sum originally lent."
The statutory implementation was Idaho Code § 57-722, which enumerated permitted investments. That list did not include securities lending or covered call options when this opinion was issued. The AG was advising the Board on what the legislature could authorize, not on what the Board could do under the existing list.
The accounting question turned on Idaho Code § 57-724, which separated income (distributable under the constitution to specific endowment beneficiaries) from securities gains (retained as part of the corpus). Treating option premium as securities gains preserved the corpus and reflected the operational reality of options as portfolio-management tools.
The AG noted the U.S. Supreme Court's Moon decision had recognized the Board's authority to sell investments at a loss for portfolio-flexibility reasons. The AG distinguished that authority from the option-strike-price question because options modify the underlying loan terms, not just sell positions for cash.
Common questions
Could the Endowment Fund Investment Board lend out securities for additional income in 1988?
Not under existing statutes. Idaho Code § 57-722 did not authorize securities lending. But the AG concluded that if the legislature added the authority, it would not violate Idaho Const. art. 9, § 11's "loan" requirement, because securities lending includes a guarantee of full repayment of principal plus interest plus an additional premium.
What about selling covered call options on securities the Endowment held?
Same answer. Not authorized under existing statutes, but constitutionally permissible if the legislature added the authority. Selling a covered call does not change the underlying loan; it just establishes terms for an optional sale during the option period. As long as the strike price plus premium repaid the principal originally lent, the transaction satisfied Engelking's "unconditional promise to repay" requirement.
Could the Board sell covered calls at strikes below the original principal?
The AG advised against it. Although State ex rel. Moon gave the Board authority to sell investments at a loss for portfolio reasons, the option-pricing question was different because options modify the underlying loan rather than just unwinding a position. The conservative reading of Engelking required the strike plus premium to repay the principal.
How should the Board account for option premium income?
As securities gains, not as distributable income. The premium is consideration for managing the underlying security position rather than income generated by the security itself.
What was the Engelking framework?
In 1969, the Idaho Supreme Court read art. 9, § 11's "shall be loaned" language strictly. To qualify as a "loan" under the constitution, the transaction must include a "guarantee of full repayment of principal as well as interest" and an "unconditional promise to repay the principal sum originally lent." That framework controlled all endowment-investment analyses for the next two decades.
Citations
Constitutions: Idaho Const. art. 8, § 2; art. 9, § 11.
Idaho statutes: Idaho Code § 57-722; Idaho Code § 57-724.
Idaho cases: Engelking v. Investment Board, 93 Idaho 217, 458 P.2d 213 (1969); State ex rel. Moon v. State Board of Examiners, 104 Idaho 640, 662 P.2d 221 (1983).
Source
- Landing page: https://www.ag.idaho.gov/office-resources/opinions/
- Original PDF: https://ag.idaho.gov/content/uploads/2018/04/OP88-01.pdf
Original opinion text
Full opinion text is preserved in the linked PDF. The opinion analyzed three questions about modern endowment investment techniques: (1) whether the Endowment Fund Investment Board could enter securities lending agreements consistent with Idaho Const. art. 9, § 11's requirement that endowment funds "shall be loaned"; (2) whether the Board could sell covered call options under Idaho Code § 57-722; and (3) whether option premium income should be treated as income or as securities gains under Idaho Code § 57-724. The AG worked from the strict "loan" framework of Engelking v. Investment Board (1969), which requires "an unconditional promise to repay the principal sum originally lent," and concluded that both securities lending and covered calls (with strike prices that repay principal) satisfied the framework. Both transactions required legislative authorization (neither was on the list in § 57-722), but the constitutional path was open. The AG also flagged two cautions: covered calls should not be sold at strike prices below the principal originally lent, and speculation was not permitted. Premium income should be accounted for as securities gains.
DATED this 4th day of April, 1988.
JIM JONES
Attorney General
State of Idaho