When a South Dakota school district, county, or city wants to invest extra cash, can it just buy shares of a mutual fund that holds U.S. Treasury bonds? Or does it have to actually own the Treasury bonds itself?
Plain-English summary
By 1987 brokerage firms were marketing "government securities mutual funds" to South Dakota school districts, counties, and cities. The pitch was that these funds held only U.S. Treasury or other federally-guaranteed securities, so they should qualify under SDCL 4-5-6's authority to invest public funds in U.S. government and federally-guaranteed securities. Auditor General Maurice Christiansen wrote AG Roger Tellinghuisen to ask whether the pitch worked.
The AG's answer was no, for a clean structural reason. SDCL 4-5-6 authorized investment in "securities of the United States and securities guaranteed by the United States government either directly or indirectly." The political subdivision had to receive an ownership interest in the actual qualifying securities. A mutual fund shareholder owned a share of the fund, not a direct slice of the underlying Treasury bonds. The fund itself was not government-guaranteed, only its holdings. If the fund failed (through bad management, fraud, or operational error), the political subdivision could lose its investment even though the Treasury bonds in the fund were performing.
The AG illustrated what did qualify: U.S. Savings Bonds, U.S. Treasury Notes, and other securities issued directly by the federal government. For "guaranteed indirectly," he listed GNMAs (Government National Mortgage Association mortgage-backed securities) and FRMACs (a securities type from the era) and other comparable securities. The common feature was that the political subdivision directly held the security or had a "direct assignment of a specific portion of the securities themselves." Pooled fund ownership did not work.
The AG closed with a careful disclaimer: he was not opining on whether mutual funds were good investments. He was only interpreting the statute. If the legislature wanted to permit mutual fund investment, it would have to amend SDCL 4-5-6 to do so.
Currency note
This opinion was issued in 1987. 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. The political subdivision investment statutes in SDCL chapter 4-5 have been amended multiple times since 1987. South Dakota has since authorized broader investment vehicles, including the South Dakota Public Funds Investment Trust (FIT) and other pooled investment options designed specifically for public entities. Local government finance officers should consult current SDCL chapter 4-5 before relying on the 1987 framework.
What the opinion meant at the time
For county treasurers, school district business managers, and city finance directors, the opinion was a stop on a marketing approach they had been hearing. Government securities mutual funds were a popular sales pitch in the mid-1980s. The AG said no. These officials had to either buy individual Treasury securities directly (or through a broker that delivered actual ownership) or use other authorized investment vehicles (CDs, savings deposits, the state's own pooled investment vehicles).
For brokerage firms marketing to South Dakota political subdivisions, the opinion narrowed the product set. Government securities mutual funds were off the table. Individual Treasury securities, GNMAs, and other directly-held federally-guaranteed instruments remained options.
For the Auditor General's office, the opinion gave a basis to flag improper mutual fund investments during audits. Subdivisions holding mutual fund shares under SDCL 4-5-6 authority were doing it wrong, even if the underlying portfolio was all Treasuries.
For political subdivisions with large permanent, trust, retirement, or building funds, the opinion still left the longer-maturity flexibility intact: those funds could be invested in securities with maturity dates beyond 18 months. The mutual fund prohibition was about the form of ownership, not the maturity profile.
Common questions
Q: What did "ownership interest" mean in practice?
A: A direct legal entitlement to the specific security. A subdivision could buy $1 million of U.S. Treasury notes through a broker and have the broker hold them in custody under the subdivision's name. That was ownership. A subdivision could not buy $1 million of a government securities mutual fund, because the fund's shareholders all owned undivided interests in the fund's portfolio, not in specific underlying securities.
Q: Why was the legislature so cautious?
A: Two reasons that the opinion implied without spelling out. First, mutual funds introduced an intermediary (the fund) whose own management decisions, fees, and operational risks affected the investment. Second, public funds carry a strong policy preference for safety and certainty. Direct ownership of government securities is the cleanest form of investment safety; pooled ownership added a layer.
Q: What was the 18-month maturity limit about?
A: SDCL 4-5-6 generally required that securities be redeemable within 18 months from purchase, for normal operating funds. Permanent, trust, retirement, and building funds were exempt from that limit and could hold longer-maturity securities. The general 18-month rule reflected a preference for liquidity in funds that might be needed for operations.
Q: What were GNMAs and FRMACs?
A: GNMAs (Government National Mortgage Association mortgage-backed securities) carried a direct U.S. government guarantee. FRMACs were another security type with federal guarantees. Both were considered "indirectly guaranteed" because they were not direct Treasury obligations, but the federal guarantee was nonetheless binding.
Q: Could a subdivision pool its money with other subdivisions?
A: The opinion didn't address pooling between subdivisions. Some states have authorized pooled investment funds specifically for political subdivisions (where the pooling vehicle is itself a public entity, not a private mutual fund). The AG's analysis would not have automatically prohibited that structure, but the SDCL 4-5-6 ownership-interest rule would have had to be considered.
Q: What about money market funds that held only government paper?
A: Same answer as for any other mutual fund. The fund was not government-guaranteed; only its underlying holdings were. A money market fund share was a fund share, not a direct holding of the underlying paper.
Background and statutory framework
SDCL chapter 4-5 set out the investment authority for political subdivisions. Chapter 4-5 was supplemented by chapter-specific provisions for counties (SDCL 7-20), municipalities (SDCL 9-22), and school districts (SDCL 13-16). The AG checked all three and found that none expanded the basic SDCL 4-5-6 authority.
The 1980s saw a proliferation of investment products marketed to local governments. Some of those products, particularly the government securities mutual funds, had a superficially compelling story: only Treasuries inside, but with the convenience of mutual fund administration. The AG's reading reflected a literal application of the statute. The statute required ownership of the security, not of a fund holding the security. Convenience did not change the legal requirement.
The opinion was not a finance lecture; the AG was explicit that he was not commenting on whether mutual funds were prudent investments. He was simply reading the statute and concluding that the legislature had not authorized that form of investment. If the legislature wanted to add mutual funds to the authorized list, it could do so by amendment. Until then, political subdivisions had to stay within the literal terms of SDCL 4-5-6.
The 1980s political subdivision investment landscape would tighten further after the Orange County, California bankruptcy in 1994, which alerted state legislatures to the risks of complex pooled investment vehicles. South Dakota's 1987 opinion was, in retrospect, a conservative position that aged well.
Citations and references
Statutes:
- SDCL 4-5-5 to 4-5-11 (general investment authority)
- SDCL 4-5-6 (US securities)
- SDCL 4-5-11 (supplemental nature)
- SDCL ch. 7-20 (county investments)
- SDCL ch. 9-22 (municipal investments)
- SDCL ch. 13-16 (school district investments)
Source
Original opinion text
Investment of public funds in securities, directly or indirectly guaranteed by the United States government
Dear Mr. Christiansen:
You have requested an official opinion from this office in regard to the following question:
QUESTION:
May school districts, counties and municipalities invest in funds created by a brokerage firm, bank, or other financial institution which has purchased securities directly or indirectly guaranteed by the Federal Government?
The answer to your question is governed by relevant statutes governing an investment of political subdivision funds, SDCL 4-5-5 through 4-5-11. SDCL 4-5-6 provides:
Any public funds which will not be needed for current operating expenses, may be invested in securities of the United States and securities guaranteed by the United States government either directly or indirectly and redeemable within eighteen months from the date of purchase. The maturity date may exceed eighteen months. Provided, however, that permanent, trust, retirement and building funds may be invested in securities having a redeemable date beyond eighteen months.
SDCL 4-5-11 provides:
Sections 4-5-5 to 4-5-10, inclusive, are supplemental to any other laws relating to the investment, deposit or administration of the public funds therein specified, and shall supersede the provisions thereof only to the extent that such other laws may restrict or prohibit investments in accordance with the provisions thereof.
A review of the relevant statutory provisions governing the separate investment powers of school districts as contained in SDCL ch. 13-16; counties as contained in SDCL ch. 7-20; and municipalities as contained in SDCL ch. 9-22 reveals there are no other statutes that grant broader investment authority.
Based upon a review of the above-discussed statutory provisions, it is my opinion, that school districts, counties and municipalities under SDCL 4-5-6 may invest in funds created by a brokerage firm, bank or other financial institution only when they receive an ownership interest in the actual securities that are issued by the United States, or the securities guaranteed directly or indirectly by the United States government. It is my opinion that the "securities of the United States" include U.S. Savings Bonds, U.S. Treasury Notes and other securities issued by the United States government. "[S]ecurities guaranteed by the United States government, either directly or indirectly," would include bonds, notes and other securities for which the United States government will guarantee payment if the original fails to perform his responsibilities. Examples of these types of securities would include G.N.M.A.s. and F.R.M.A.C.s and other comparable types of securities.
Under SDCL 4-5-6, political subdivisions cannot invest in mutual funds or other types of equity funds that purchase United States securities or securities guaranteed by the United States government either directly or indirectly where the local political subdivision would not acquire an ownership interest in the securities themselves. The reason for this restriction is that the mutual funds themselves are not guaranteed directly or indirectly by the United States government. In order to acquire an ownership interest, the local governmental entity must have a direct assignment of a specific portion of the securities themselves.
In rendering my opinion, I am in no way making any statement concerning the propriety of investments in mutual funds and other types of equity securities. This opinion is only based upon my interpretation of the relevant statutes.
Sincerely,
Roger A. Tellinghuisen
ATTORNEY GENERAL