Elizabeth A. Grob
Ahlers & Cooney, P.C.
100 Court Avenue, Suite 600
Des Moines, IA 50309-2231
Telephone: 515-243-7611
FAX: 515-243-2149
bgrob@ahlerslaw.com
663110
This material and the oral
presentation of Beth Grob are
intended merely to identify
issues and are not intended to
be a definitive analysis of the
subjects discussed. It is not
intended that reliance be placed
upon these materials without
confirming independent
research by and consultation
with an attorney licensed in the
State of Iowa.
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Iowa Code Chapter 12B: Security of the
Revenue
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Standard of Care Required: . . . shall exercise the
care, skill, prudence and diligence under the
circumstances then prevailing that a prudent person
acting in a like capacity familiar with such matters
would use to attain the goals of this section.
“This standard requires that when making
investment decisions, a public entity shall consider
the role that the investment or deposit plays within
the portfolio of assets of the public entity and the
goals of [investment prudence].”
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Primary Goals of Investment Prudence, in the
following order of priority:
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Safety of the principal;
Maintaining the necessary liquidity to match
expected liabilities.
Reasonable return.
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Must have a written investment policy which
shall address the Goals of Investment
Prudence, compliance with state law,
diversification, maturity, quality, and
capability of investment management.
The policy must be periodically reviewed.
• The written investment policy must be delivered to:
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• Governing Body/officer of entity to which the policy
applies.
• All depository institutions or fiduciaries for public
funds of the public entity.
• The auditor of the public entity.
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Authorized investments:
Obligations of the US Governments, its agencies and
instrumentalities
• Certificates of Deposit and other evidences of
deposit at federally insured depository institutions
approved pursuant to chapter 12C.
• Prime Bankers Acceptances: vehicle created to
facilitate commercial trade transaction similar to a
Letter of Credit Guarantee payment of delivery of
goods
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Bank is issuer.
Must mature within 270 days.
Eligible for purchase by a Federal Reserve Bank.
10% portfolio; 5% single issuer.
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Authorized investments:
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Commercial Paper: Short-term, unsettled promissory
note issued in the market by a company; Buy & Hold
typically.
• Mature within 270 days.
• Rated within 2 highest classifications by at least one of
the standard rating services approved by the
Superintendent of Banking.
• 10% portfolio; 5% single issuer; 5% rated in second
highest classification
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Authorized investments:
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Repurchase Agreements: A sale of a security with a
commitment by the seller to buy the securities back
from the purchaser at a specified price on a
designated date.
• Must be collateralized with obligations of the US
Government, its agencies or instrumentalities.
• Possession of collateral must be directly by the
governmental entity or through an authorized
custodian.
• Custodial Agreement must follow rules for Public
Funds Custodial Agreements required by IA Cod
Section 12B.10C (and rules of State Treasurer).
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Authorized investments:
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Money Market Funds: SEC-registered fund that
meets 2a-7 guidelines
Joint Investment Trust Organized under Chapter 28E
& meets 2a-7 guidelines
• Registered with SEC; OR
• Rated within the 2 highest classifications by at least one
of the standard rating services approved by the
Superintendent of Banking.
• Manager/Investment Adviser must be registered with
SEC under the Investment Advisor Act.
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Authorized investments:
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Warrants/or improvement certificates of a levee or
drainage district.
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Authorized investments:
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Deposits or CDARS – Certificate of Deposit Account Registry
Service
• If public funds deposited in a depository, authorized by 12C.1,
any uninsured portion in that depository may be invested in
insured deposits or certificates of deposit arranged by the
depository that are placed in or issued by one or more federally
insured banks or savings associations regardless of location for
the account of the public funds depositor if all of the following
are satisfied:
• Full amount of principal & any accrued interest on such public funds
or each such certificate of deposit issued shall be covered by federal
deposit insurance.
• the depository, either directly or through an agent or subcustodian,
shall act as custodian of the insured deposits or certificates of deposit.
• On the sameday that the public funds deposits are placed or the
certificates of deposit are issued, the depository shall have received
deposits in an amount eligible for FDIC from, and with regard to
certificates of deposit, shall have issued certificates of deposit to,
customers of other financial institutions wherever located that are
equal to or greater than the amount of public funds invested under
this subsection by the public funds depositor through the depository.
INVESTMENT OF PUBLIC FUNDS & PUBLIC FUNDS COLLATERALIZATION
• Authorized investments for Bond Proceeds:
• Governed by Iowa Code section12C.9
• 12B.10(4)(a)(1-9) - #8 is CDARS
• 12B.10(5)(a)(1-7)
• Guaranteed investment contract and/or tax-exempt bonds
• Must be rated within the 2 highest classifications by at least 1 rating
service approved by the superintendent of Banking
• All investments must comply with section 148 of the
Internal Revenue Code.
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Unauthorized Investments
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The trading of securities for the purpose of
speculation and the realization of short term trading
profits.
Reverse Repurchase Agreements (The purchase of
securities with the agreement to sell them at a higher
price at a specific future date. For the party selling
the security (and agreeing to repurchase it in the
future) it is a repo for the party on the other end of
the transaction (buying the security and agreeing to
sell in the future) it is a reverse repurchase
agreement.).
Futures and Options Contracts.
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Maturity and Procedural Limitations
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“Operating Funds” must mature within 397 days or less and
must be invested in investments authorized by law. If not a
designated “operating fund” than invest in maturities longer
than 397 days.
If the use of a custodial agreement is required (i.e., repurchase
agreements) the custodial agreement must comply with rules
adopted by the Treasurer of the State and must include a
statement that all investments be made in accordance with the
laws of the State of Iowa.
A contract for the investment or deposit of public funds shall
not provide for compensation of agent based upon investment
performance.
All investment records are public documents and if third party
fails to produce requested records in a reasonable time, public
entity shall not make any new investments with third party or
renew investments.
Diversify portfolio to eliminate risk of loss resulting from
overconcentration of assets in a specific maturity, a specific
issuer, or a specific class of securities.
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Public Funds Collateralization
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Generally, how does the law work?
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Under the new law, when a bank accepts a deposit of public
funds, the bank agrees to pledge certain collateral in accordance
with Iowa Code section 12C.22 to secure the public funds
deposited. If collateral must be pledged, the bank is known as a
"pledging bank". If the bank fails to pay a check, draft or warrant
of a public officer, if the bank closes, or in other limited
circumstances, the Treasurer of the State may liquidate the
pledged collateral to pay the claims of the public entity. Now,
when the Treasurer of the State pays claims of public entities, the
claims will be paid from the following sources in the following
order:
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Any applicable insurance (i.e., first $250,000 on deposit is insured by the
FDIC);
Liquidation of any pledged collateral or funds received from a Letter of
Credit used by a pledging bank to secure the public funds;
Assets of the bank which are liquidated within 30 days of the closing of the
bank;
Funds in the State Sinking Fund; and
Assessments against all remaining banks whose public funds deposits
exceed FDIC insurance coverage.
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Which banks have to pledge collateral?
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Each bank that accepts public funds must determine if it must pledge
collateral. A bank must pledge collateral, thus becoming a "pledging
bank", if the total amount of public funds (i.e., all deposits by a city,
county, school district, municipal utility, etc. must be included) on deposit
in the bank exceeds the total capital of the bank. Iowa Code section 12C.22
sets out a specific calculation which each bank must make to determine its
total capital.
This means a bank may not be a pledging bank one day but may be a
pledging bank the next day, depending on the total capital of the bank
and the amount of public funds on deposit on that particular day. For
example, a public entity maintains an account at Bank X and on
approximately October 14 Bank X would not be a pledging bank under the
statute because the total amount of public funds would not exceed the total
capital of Bank X. However, when the public entity receives its property
tax collections on approximately October 15, Bank X may be a pledging
bank because the total amount of public funds on deposit would exceed
the total capital of Bank X on that day.
The Treasurer of the State's web page states that "[b]anks are required to
determine if circumstances on any given day require them to pledge
securities that day”.
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Who holds the pledging bank's collateral?
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The pledging bank must pledge collateral which will
be held by an "approved custodian". Generally, an
approved custodian may not be the pledging bank,
an affiliate bank or subsidiary of the pledging bank
or any bank in which the approved custodian or any
affiliate has direct or indirect control of the pledging
bank. The Treasurer of the State will develop a list
of criteria which a bank must meet to be an
approved custodian.
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What type of securities are "eligible collateral"?
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Iowa Code section 12C.22(6) lists specific securities
and other forms of collateral which are acceptable.
This includes cash and, in certain circumstances, a
Letter of Credit. A Letter of Credit will be held in
the Treasurer of the State's vault, not by an approved
custodian.
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May a pledging bank withdraw, substitute, or
change the collateral?
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Yes. The pledging bank must submit a Certificate
and Approval for Withdrawal, Substitution, or
Addition of Collateral to the approved custodian,
along with a calculation that demonstrates once the
transaction is complete, there is sufficient collateral
pledged. Before completing the transaction or
releasing any collateral, the approved custodian
must verify that, after the transaction is complete,
the total collateral market value is equal to or
exceeds the total excess public funds. If the
calculation is verified the approved custodian will
then notify the Treasurer of the State and the
pledging bank of the completion of the transaction.
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What are the consequences if a pledging bank
violates the law?
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If a pledging bank violates any provision of the laws,
rules, agreements proscribed by the Treasurer of the
State, or fails to fulfill its duties, or applicable FDIC
insurance coverage is suspended or terminated, the
Treasurer of the State may suspend or terminate the
bank's ability to accept uninsured public funds. The
public entity will be notified of the suspension or
termination of a bank's ability to accept uninsured public
funds by notices included in the monthly rate-setting
notice posted on the Treasurer of the State's Web site. If a
public entity's funds are on deposit with a suspended or
terminated pledging bank, the public entity may have an
illegal investment and/or deposit under Iowa law and
should consult with their attorney.
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What are the consequences if an approved
custodian violates the law?
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If an approved custodian violates any provision of
the laws, rules, agreements proscribed by the
Treasurer of the State, or failed to fulfill its duties,
the Treasurer of the State may suspend or terminate
the bank's designation as an approved custodian.
The Treasurer of the State will notify the pledging
bank of the suspension or termination and the
pledging bank must immediately secure the services
of another approved custodian.
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Municipal investment policies have been a
statutory requirement for a number of years.
However, some of the details are worth
reviewing periodically. Test your knowledge
on investment concepts and policy provisions
required under the Code of Iowa with the
following Iowa investment policy pop quiz.
Good luck!
1. True or false. It is the responsibility of the city
council to adopt the written investment policy
required by the Code of Iowa?
1. True or false. It is the responsibility of the city
council to adopt the written investment policy
required by the Code of Iowa?
True. The city council must approve a written
investment policy.
2. True or false. A copy of the city investment
policy must be given to the auditor performing
the audit for the city.
2. True or false. A copy of the city investment
policy must be given to the auditor performing
the audit for the city.
True. The written investment policy must be
provided to the auditor. In addition, the city is
required to maintain a copy, and provide a copy
to the city treasurer and all depository institutions
or fiduciaries for public funds of the city.
3. What type of agreement must a municipal
finance officer have when investing in securities?
• a.
Deposit Agreement
• b.
Public Funds Custodial Agreement
• c.
Repurchase Agreement
• d.
None of the above
3. What type of agreement must a municipal
finance officer have when investing in securities?
• a.
Deposit Agreement
• b.
Public Funds Custodial Agreement
• c.
Repurchase Agreement
• d.
None of the above
The answer is b. and sometimes c. Code Section 12B.10A requires the city to
have a public funds custodial agreement with any person or entity that is
authorized by the city to act as a custodian of public funds investments. This
custodial agreement must comply with rules established by the state
treasurer's office and the Iowa attorney general. A public funds custodial
agreement is not required for deposits made in an Iowa bank, credit union,
savings and loan, investments in IPAIT or direct investments in a money
market mutual fund. If a city is investing in securities through a repurchase
agreement, the treasurer should have a public funds custodial agreement
with the custodian of the securities and a repurchase agreement with the
seller of the securities.
4. As defined in the Iowa public investment
statutes, what is the difference between operating
funds and non-operating funds?
4. As defined in the Iowa public investment
statutes, what is the difference between operating
funds and non-operating funds?
As defined by Code Section 12B.10A, operating
funds are funds reasonably expected to be
expended during a current budget year or within
15 months of receipt. The law requires operating
funds to be identified and invested in investments
with maturities of 397 days or less.
5. Which of the following securities are
appropriate investments for "municipal operating
funds" as defined in the Code of Iowa?
• a.
A five year to maturity U.S. agency
security callable in one year "with a coupon so
high it has to be called."
• b.
"AAA" rated commercial paper equal to 10
percent of investment portfolio.
• c.
Uncollateralized repurchase agreement.
• d.
One year to maturity HUD note equal to
25 percent of investment portfolio.
5. Which of the following securities are appropriate
investments for "municipal operating funds" as defined in
the Code of Iowa?
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a. A five year to maturity U.S. agency security
callable in one year "with a coupon so high it has to be
called."
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b. "AAA" rated commercial paper equal to 10 percent
of investment portfolio.
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c. Uncollateralized repurchase agreement.
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d. One year to maturity HUD note equal to 25
percent of investment portfolio.
The answer is d. This U.S. agency security is backed by the
full-faith-and-credit of the federal government, is less than
397 days to maturity and has no concentration limitation.
6. Yes or no. Can a city invest operating funds in a
short-term bond mutual fund that invests solely
in U.S. Treasuries or government agency
securities?
6. Yes or no. Can a city invest operating funds in a
short-term bond mutual fund that invests solely
in U.S. Treasuries or government agency
securities?
No. A city may invest in a money market mutual
fund, which is operated pursuant to Rule 2a-7,
but not in a bond fund, even if the bond fund
invests only in U.S. treasuries or government
securities.
7. Yes or no. The local bank has suggested that
you open a sweep account. The agreement will
require the bank to "sweep" moneys in the
account in excess of $50,000 into a repurchase
agreement. Is the money that is swept out of the
account insured by the Federal Deposit Insurance
Corporation (FDIC)? Is a public funds custodial
agreement required for the “sweep” account?
7. Yes or no. The local bank has suggested that you open a
sweep account. The agreement will require the bank to
"sweep" moneys in the account in excess of $50,000 into a
repurchase agreement. Is the money that is swept out of
the account insured by the Federal Deposit Insurance
Corporation (FDIC)? Is a public funds custodial
agreement required for the “sweep” account?
No. Once the money is taken out of the bank account and
invested in a repurchase agreement, it is no longer a
deposit under Iowa or federal law. The funds swept out of
the account are invested in securities, not in deposits.
Therefore, neither FDIC insurance or the state's deposit
protection program would cover the funds. Since the
“sweep” account is a repurchase agreement, the city
should have a public funds custodial agreement with the
bank that is holding the securities on the city’s behalf.
8. Yes or no. Can bond proceeds be invested
differently from operating funds?
8. Yes or no. Can bond proceeds be invested
differently from operating funds?
Yes. Code Section 12C.9 permits bond proceeds to be
invested in all of the investments permitted for
operating funds found in Code Section 12B.10 and
investment contracts or tax-exempt bonds. The
investment contract or tax-exempt bond must have a
credit rating of at least AA from Moody's or Standard
& Poor's. All bond proceed investments must be
permitted under section 148 of the Internal Revenue
Code and applicable regulations under that section.
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9. Which of the following securities are eligible
collateral for a repurchase agreement?
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"AAA" rated commercial paper
U.S. T-Bill
FHLB (Federal Home Loan Bank) security
9. Which of the following securities are eligible
collateral for a repurchase agreement?
"AAA" rated commercial paper
• U.S. T-Bill
• FHLB (Federal Home Loan Bank) security
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The answer is b. or c. The Code of Iowa requires that
repurchase agreements must be collateralized by
obligations of the United States government, its
agencies or instrumentalities. Further, the city must
take possession of the securities directly or through
an authorized custodian pursuant to a public funds
custodial agreement.
10. True or False. Because the Federal Reserve
has drastically reduced interest rates, the local
bank may pay a lower interest rate on a certificate
of deposit than the public funds investment rate
set by the Code of Iowa.
10. True or False. Because the Federal Reserve
has drastically reduced interest rates, the local
bank may pay a lower interest rate on a certificate
of deposit than the public funds investment rate
set by the Code of Iowa.
False. Code section 12C.6 requires a committee to
meet monthly to establish the minimum rate to be
earned on public funds invested in a certificate of
deposit. For the current rate, visit
http://www.treasurer.state.ia.us/rates/.
11.Yes or no. The local bank quotes an interest
rate on a certificate of deposit for the city’s
operating funds which is substantially higher
than the other quotes received. However, the
local bank indicates that the total amount
invested will be divided up into certificates of
deposit which are covered by Federal Deposit
Insurance coverage limits (i.e., principal and
accrued interest for each certificate issues is
$100,000 or less) and which will be held by
federally insured banks or savings associations
throughout the country. Is this an authorized
investment under Iowa law for operating funds?
What about for bond proceeds?
11. Yes or no. The local bank quotes an interest rate on a certificate of deposit
for the city’s operating funds which is substantially higher than the other
quotes received. However, the local bank indicates that the total amount
invested will be divided up into certificates of deposit which are covered by
Federal Deposit Insurance coverage limits (i.e., principal and accrued interest
for each certificate issues is $100,000 or less) and which will be held by
federally insured banks or savings associations throughout the country. Is
this an authorized investment under Iowa law for operating funds? What
about for bond proceeds?
Yes. Code section 12B.10(7) authorizes investment in the CDARS (Certificate
of Account Registry Service) program for operating funds. This program
allows a local institution to place the city’s deposit into other certificates of
deposit at other federally insured banks or savings association throughout the
country. If the city has more than one certificate of deposit placed through
the CDARS program, the city should ensure that it has only one certificate of
deposit at the other financial institutions throughout the country to ensure
full FDIC coverage. For bond proceeds, Code section 12C.9 lists only those
investments authorized in 12B.10(4)(a)(1-9) (includes CDARS) and
12B.10(5)(a)(1-7), along with guaranteed investment contracts and tax-exempt
bonds, as authorized investments.
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12. Yes or no. A securities representative offers
to sell the city commercial paper that is rated
“AAA” and matures within 200 days. The
purchase of the commercial paper will not violate
the statutory limits of concentration for investing
in commercial paper. However, upon reading the
offering terms in a “private placement
memorandum”, the city administrator notices
that the commercial paper is not registered with
the Securities and Exchange Commission (“SEC”)
and may only be purchased by an “accredited
investor”. Is the city authorized to purchase the
commercial paper?
12.Yes or no. A securities representative offers to sell the city
commercial paper that is rated “AAA” and matures within 200
days. The purchase of the commercial paper will not violate
the statutory limits of concentration for investing in commercial
paper. However, upon reading the offering terms in a “private
placement memorandum”, the city administrator notices that
the commercial paper is not registered with the Securities and
Exchange Commission (“SEC”) and may only be purchased by
an “accredited investor”. Is the city authorized to purchase the
commercial paper?
Maybe. Noting “some degree of uncertainty” under current
law, the SEC recently proposed adding “governmental body”
to the list of legal entities that can be an “accredited investor”
under SEC Regulation D and Rule 144A. Until the SEC acts on
the proposal it remains an open question. Unregistered
securities, it should be noted, may present very different risks
than more traditional investments.