Can South Dakota's permanent school fund be invested in SBA-guaranteed loans (where SBA guarantees 90% of the loan) by purchasing the guaranteed 90% portion? The Constitution restricts investments to 'securities guaranteed by the United States,' and the statute restricts to 'securities fully guaranteed by the United States.'
Plain-English summary
In 1968 the Small Business Administration's regional office in Sioux Falls proposed a new use for South Dakota's permanent school fund. The SBA guarantees portions of bank loans to small businesses; in 1968 the guarantee could be up to 90% of an SBA-eligible loan, with the bank servicing the loan and remitting 90% of the principal payments to the holder of the SBA guarantee certificate. The SBA proposed that the Commissioner of School and Public Lands, with Board of School and Public Lands and Governor approval, could direct the State Treasurer to disburse permanent school fund money in exchange for assignments of the SBA-guaranteed 90% portions of these loans. The fund's investment would be "100% guaranteed" by SBA (within the limits of the 90% allocation).
The Regional Director argued the program would help South Dakota small businesses by making capital more available, would generate state-of-the-art-rate interest income for the school fund, and had already been put in place in North Dakota, Utah, and Wyoming for state pension funds. Mr. Linn asked AG Gordon Mydland whether the program was legally available to South Dakota.
Mydland reviewed two layers of restriction.
The Constitution at Article VIII, Section 11 restricts permanent school fund investments to "bonds of the United States, securities guaranteed by the United States, and other instruments." The phrase "securities guaranteed by the United States" might be readable to permit investments that were guaranteed 100% via a partial-but-fully-secured arrangement. But the literal text says "securities guaranteed by the United States," not "the guaranteed portion of partially guaranteed securities."
SDCL 1967 5-10-18 was tighter. It limited investments to "bonds of the United States" and "securities fully guaranteed by the United States, including Farmers Home Administration and Federal Housing Administration mortgages." The statute used "fully guaranteed" and did not contemplate buying portions of partially guaranteed securities.
Mydland's analysis worked through three questions. On Questions 1 and 2 (whether the Constitution and statute permitted the investment), the answer was no. The Constitution's text was potentially flexible but the statute was tighter. To accommodate the SBA program, the legislature would need to amend SDCL 5-10-18 to authorize partial-guarantee or guaranteed-portion investments. Even then, the constitutional question might remain.
On Question 3 (whether "by the United States" includes "by an agency of the United States"), the answer was yes. The U.S. Supreme Court treated SBA as a non-incorporated federal agency and integral part of the U.S. government (U.S. v. Stuart). A 100% SBA guarantee would equate to a U.S. guarantee.
On Question 4 (whether a constitutional amendment would be needed even if the statute were amended), Mydland declined to predict. The constitutional text was ambiguous; a court would have to decide whether "securities guaranteed by the United States" reached 90%-guaranteed instruments. The safer path was a constitutional amendment to expressly authorize investment in SBA-backed securities.
The net answer was that the program could not proceed without legislative or constitutional action. Mydland recommended a constitutional amendment as the cleanest path.
Currency note
This opinion was issued in 1968 during AG Gordon Mydland's tenure. Subsequent statutory amendments, constitutional amendments, and changes in the SBA program have substantially changed the landscape. Treat this page as historical context, not current legal advice. The permanent school fund's investment authority is now governed by current SDCL chapter 5-10 and Article VIII Section 11 as they currently stand, with various updates since 1968. Modern questions about permitted investments should be verified against current statutory and constitutional text and any applicable Investment Office policies.
What the opinion meant at the time
For the Commissioner of School and Public Lands, the opinion meant declining the SBA proposal as proposed. The fund's investment mandate did not stretch to partial-guarantee securities.
For the SBA Regional Director, the opinion meant the South Dakota program would need either a state-law change or significant restructuring. The North Dakota model (where the Bank of North Dakota's statute expressly authorized partial-guarantee investments) was a possible template for legislative reform.
For state legislators interested in supporting small business development, the opinion identified the legislative path. Either amend SDCL 5-10-18 to expand permitted investments, or propose a constitutional amendment to clarify Article VIII Section 11.
For other states' investment officers watching how South Dakota handled the question, the opinion was a useful data point: state constitutional restrictions on public-fund investments are real and can block creative arrangements that look reasonable from a financial perspective.
Common questions
Q: Why are permanent school fund investments so restricted?
A: Permanent school funds are typically constitutional trust funds intended to generate perpetual income for public education. The restrictive investment rules reflect a historical concern about preserving principal. The "fully guaranteed by the United States" requirement minimizes principal risk; market-rate or partially-guaranteed investments accept more risk for potentially higher returns, but at the cost of principal safety.
Q: What was the SBA loan program doing differently than the FHA mortgage program?
A: FHA mortgages were fully guaranteed (with FHA accepting 100% of the credit risk in exchange for premiums paid by the borrower). The 1968 SBA program had a 90% guarantee, leaving 10% risk with the bank. The school fund could buy FHA mortgages but not SBA partial guarantees because the statute required full guarantee.
Q: What did "by an agency of the United States" mean?
A: SBA is an agency of the U.S. government. The U.S. Supreme Court in U.S. v. Stuart had held that SBA is a non-incorporated federal agency and an integral part of the U.S. government. So "guaranteed by the United States" and "guaranteed by an agency of the United States" are legally equivalent.
Q: Could the program work if the school fund bought 100% of an SBA-guaranteed loan?
A: That would still be a partial federal guarantee (only 90% federally guaranteed). The remaining 10% would be bank risk, not federal risk. The statute did not allow that even if the structural arrangement passed through the bank.
Q: Why didn't Mydland just liberally interpret the Constitution?
A: He noted that an aggressive interpretation was theoretically possible but would be "by no means free from doubt." His role was advisory. A definitive answer required either legislative action or a court ruling. He recommended a constitutional amendment as the safest path.
Q: Did the constitutional amendment ever happen?
A: That's outside the scope of this opinion. Subsequent state-level reforms could have addressed the issue. Modern users should check the current Article VIII Section 11 text for any 1970s or later amendments.
Background and statutory framework
State permanent school funds are a 19th-century concept rooted in federal land grants to states for the support of public education. Most western and midwestern states have such funds, originally capitalized by sales of "school sections" of federal land. South Dakota's permanent school fund follows the standard pattern: principal is preserved permanently, income from investments funds public schools.
The conservative investment mandate is the trade-off for permanence. A trust fund with permanent principal can afford to invest only in safe securities; loss of principal is not recoverable through future appropriations the way ordinary general fund losses can be made up.
The 1968 SBA proposal was an attempt to bridge a different policy goal (supporting small business development) with the school fund's investment infrastructure. The proposal made financial sense for both sides: the fund got higher-yielding paper, the SBA got a buyer for its guarantee portions, and small businesses got loans. But the school fund's restrictive investment mandate could not accommodate the partial-guarantee structure without statutory or constitutional change.
Mydland's recommendation of a constitutional amendment reflects judicial reluctance to expand "fully guaranteed" by interpretation. The legislature could attempt a statutory expansion of SDCL 5-10-18, but the constitutional text would still set a ceiling. The cleanest fix was to align the constitution with the desired program.
Citations and references
Constitutional provisions:
- S.D. Const. Art. VIII, § 11 (permanent school fund investments restricted to U.S. bonds and guaranteed securities)
Statutes:
- SDCL 1967 5-10-18 (permanent school fund investments; "fully guaranteed by the United States")
Cases:
- U.S. v. Stuart, 271 F. Supp. 939 (SBA is non-incorporated federal agency)
Federal law:
- 15 U.S.C. §§ 631-647 (creation of SBA)
Source
Original opinion text
Investment of permanent school funds in Small Business Administration loans, constitutional limitations
Dear Mr. Linn:
We have your request for an official opinion as to investing a portion of the permanent school funds of the State of South Dakota in Small Business Administration loans. An examination of the file reveals that heretofore the Regional Director of the Small Business Administration, Sioux Falls, South Dakota, submitted a proposal that the Commissioner of School and Public Lands, as custodian of the common school permanent fund and other education funds, make disbursements from such fund in exchange for an assignment from banks of the guaranteed portions of SBA guaranteed loans. Among other things, the Regional Director stated:
"We propose that the Commissioner of School and Public Lands, with the approval of Board of School and Public Lands and of the
Governor, give written authorization to the State Treasurer, as custodian of the Common School Permanent Fund and other education funds (hereinafter referred to as "fund"), to make disbursements from Fund in exchange for assignments from banks of the guaranteed portions of SBA guaranteed loans.
"SBA loans to small businesses and industries can be authorized up to $350,000 (SBA share), for terms up to fifteen years for construction, ten years for other than working capital and construction, and six years for working capital. Such loans may be guaranteed by SBA up to 90% and bear interest at the rate set by the bank, but not to exceed 8% per annum. Out of the interest set by bank, it pays SBA 1/2 of 1% as the guaranty fee on the guaranteed portion and the bank services the loan. Only the guaranteed portion, or a part thereof, would be assigned to the Fund, which would make its investment 100.% guaranteed by the Small Business Administration, an agency of the United States Government."
We have examined the guarantee agreement and the form of the proposed assignment of the securities to the permanent school fund that will be used by SBA and the bank that makes the loan to the borrower. The guarantee is 90% of the outstanding balance of the loan. The proposed instrument whereby the bank would assign the guaranteed portion of the loan sets out therein that the bank will collect the installments on the loan, as paid, and 9/10 of the payments received and collected on the principal of said loan will be remitted monthly to the assignee of the certificate of guaranty. In other words, you would be purchasing 90% of the security. The Regional Director of SBA also states that the program, as outlined in his letter, has been placed in effect in North Dakota, Utah and Wyoming with state employee pension funds and investments by the Bank of North Dakota. The types of funds in North Dakota and Wyoming are similar to South Dakota's Teacher's Retirement Fund, which is not affected by the constitutional limitation that we are concerned with in this opinion.
It is interesting to note, however, that in North Dakota the statute which pertains to investments by the Bank of North Dakota provides that:
"It may make such loans and advances of credit and purchases of obligation representing loans and advances of credit as are insured by, or guaranteed, in any manner, in part or in full, by the United States or any instrumentality thereof."
While it is not the function of this office to determine the advisability of such an investment, it would seem there is merit to the Regional Director's proposal wherein he states in his letter of June 12, 1968 as follows:
". . . it will make it possible for banks in this state to make loans to small business concerns which otherwise could not be made on account of unavailability of funds. It would permit banks to cultivate profitable business and industry accounts, well secured, and at the same time enable the firm to obtain a very favorable interest rate at no risk."
We are aware of the desire of your office to aid the development of industry in the State of South Dakota if this can be legally accomplished and a higher income from the investment be realized.
By assignment of the Certificate of Guaranty to the permanent school fund of the bank involved and an agreement with the bank and the Small Business Administration, it would seem that the fund could be protected 100%. The Regional Director states that the permanent school fund share will be fully guaranteed. On the basis of the proposal submitted, it can be seen that in the final analysis the investment could be fully protected.
You have submitted four questions which will be answered in the order in which they are asked. Questions one and two are answered together.
"1. Does the Constitution, Article VIII, Section 11 permit the investment of permanent school funds in SBA loans?"
"2. Does SDCL 5-10-18, as amended, permit investment in any portion of funds not fully guranteed by the United States?"
Article VIII, Section 11 provides as to pertinent parts as follows:
"The moneys of the permanent school fund and educational fund shall be invested by the Commissioner of School and Public Lands only in hands of the United States, securities guaranteed by the United States . . ."
"The Legislature shall provide by law, such rules, regulations and safeguards a it may deem necessary to secure safe and continuous investment of such funds so far as possible, and to provide the highest income compatible with safety investments."
SDCL 1967 5-10-18 provides as to pertinent parts as follows:
"The moneys of the common school permanent fund and other education fund shall be invested only in: (1) bonds of the United States; (2) securities fully guaranteed by the United States, including Farmers Home Administration and Federal Housing Administration mortgages; . . ."
The answer to Questions 1 and 2 is by no means free from doubt and one that can only be authoritatively answered by the Supreme Court of South Dakota. By giving the phrase in the Constitution, that states:
".. securities guaranteed by the United States"
a liberal interpretation, we could conceivably interpret such statement meaning any investment in which the permanent school fund is protected 100% as is the case here, despite the fact that the security is actually only guaranteed by the United States to the extent of 90%.
The State Constitution gives the Legislature broad rule making powers with respect to the investment of the permanent school fund. However, that body has not seen fit to liberalize or broaden the right of such investments. On the other hand, SDCL 1967 5-10-18 narrows and restricts the right to securities guaranteed 100% and no authorization is given to the purchase of a portion of a security, even though that portion be guaranteed. Also, SDCL 5-10-18 implies very strongly, and may be read to mean that the Legislature in tended to limit such investments to loans secured by real estate. To get a different result we would have to read SDCL 5-10-18 as follows:
"Securities, secured or unsecured, or a portion thereof guaranteed in whole or in part, by the United States."
Therefore, the answer to Questions 1 and 2 is in the NEGATIVE.
"3. SBA loans are guaranteed by the Small Business Administration, an agency of the United States Government. The statute provides that to be eligible, securities must be guaranteed 'by the United States.' Are the terms 'by the United States' and 'by an agency of the United States' of identical legal force and effect?"
The answer to this question is in the AFFIRMATIVE. The Small Business Administration was created by an Act of Congress and is found in 15 USCA Section 631 through 647. In the case of U. S. v. Stuart, 271 F. Supp. 939, the court held that the Small Business Administration is a non-incorporated Federal Agency and an integral part of the United States Government. The phrase, "by the United States" and the term "by an agency of the United States" are of identical legal force and effect.
"4. In the event that the Constitution does provide for the investment of SBA loans, would SDCL 5-10-18 preclude such action until such time as this law was amended?"
We are unable to definitely ay that the phrase "securities guaranteed by the United States" in Article VIII, Section 11 could by legislative rules and regulations be defined to provide for investment in SBA loans. Such an enactment by the Legislature would raise the question of such law's constitutionality. I make no comment nor express any opinion as to the constitutionality of such an act by the Legislature.
It is my opinion that it would be preferable to amend the Constitution to authorize you to invest permanent school funds in SBA loans.
Respectfully submitted,
Gordon Mydland
Attorney General