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December 19, 2019 Articles

Maximizing Returns and Avoiding Liability in the Investment and Management of Public Funds

Recent Pennsylvania and Colorado amendments highlight the importance of consistently reviewing state legislation related to public funds and pensions.

By Donald F. Winningham III, Kathryn B. Rockwood, and Christy Boardman

While the Employee Retirement Income Security Act sets federal minimum standards for private employee benefit plans, employee benefit plans maintained by local governmental employers are not subject to similar federal guidance. No overarching federal law governs the investment and management of public funds. Instead, local government public funds and public pension funds are subject to a wide variety of state and local regulations.

Because every state has its own statutory scheme regarding the investment and custody of public funds and public pension funds, understanding and abiding by applicable laws and regulations require analysis akin to peeling an onion. Adding another layer, counties, municipalities, public agencies, and public authorities often also have their own codes, ordinances, and regulations that address these same issues. Sometimes applicable laws and regulations are expansive (especially in the case of home rule states), and in other cases they are restrictive. As explained below, having a thorough understanding of laws and regulations governing public funds is crucial to both maximizing returns for public entities and avoiding pitfalls when advising public entities or managing public funds.

Maximizing Returns for Public Entities

Although applicable provisions vary state by state and locality by locality, the overarching theme of these provisions is the protection of principal paired with the maximization of every dollar. Legislation in most states requires investment in accordance with the prudent person standard and provides for a selection of investment options that have been deemed “safe” for public funds. Many states also offer a carve-out from more draconian “safe” investments and give public entities discretion to broaden their options for return. Accordingly, despite restrictive limitations on investment vehicles, applicable statutes and regulations provide options for a greater return in some instances.

For example, Connecticut limits the investment of municipal funds to a narrow group of investments, such as U.S. government and agency obligations and municipal bonds. See Conn. Gen. Stat. § 7-400. However, Connecticut also offers an escape for pension and retirement funds by allowing the terms of a benefit plan to override these statutory restrictions and thereby expand permissible investment options. See id. at § 7-450. Similarly, Florida statutes governing the permissible investments of public retirement funds provide additional flexibility if an investment is otherwise authorized by ordinance. See Fla. Stat. §§ 112.661, 215.47. While states generally provide “ground floors” for the investment of public funds, carefully drafting local ordinances and investment policies may provide relief from statutory limitations.

Avoiding Pitfalls When Advising Public Entities or Managing Public Funds

Despite the flexibility provided by some state statutory schemes, the unique and varying nature of laws and regulations governing the investment of public funds creates hazards for wealth management teams that advise public entity clients on how to invest. Consulting on or managing these accounts requires compliance with state and local statutes, regulations, and ordinances in addition to the relevant policies adopted by the public entity itself. These complex regulatory schemes provide a plethora of opportunities for missteps and noncompliance that, in some cases, may expose investment consultants, investment managers, and public fund trustees to liability.

For instance, Colorado statutes that govern pension plans for firefighters and police officers complicate matters by differentiating regulations for these plans based on an employee’s hire date. See Colo. Rev. Stat. §§ 15-1-304, 31-30.5-501. The differences, particularly in the types of investments allowed for these Colorado plans, are stark. If a Colorado pension fund were to rely on the wrong statute in crafting its investment policy or if an investment consultant were to reference the wrong pension statute in recommending investments to the fund, such investments could run afoul of the statute governing a particular type of plan. Such a mistake could create liability not only for the plan’s trustees but also for a firm managing the investments of the plan if that firm sold or recommended investments to the plan that did not comply with applicable law. See id. at §§ 24-75-601.1, 24-75-601.5. Specifically, pursuant to Colorado law, the firm could be liable for any loss of principal resulting from such an investment along with certain costs, fees, and interest, or could be compelled to repurchase the prohibited instrument for the greater of the original purchase price or the original face value, plus any accrued interest. See id.

In other contexts, liability for missteps in managing or investing public funds may depend on the role a firm accepts in assisting a public entity. Liability could be based on (1) whether an investment consultant or manager is considered a “fiduciary” under a state’s statutory scheme or the public entity’s investment policy or (2) whether an investment consultant or manager exercises discretion over the investment of public funds. In Illinois, for example, any person who exercises discretionary authority, renders investment advice, or renders advice on the selection of fiduciaries in connection with a pension fund or retirement system is considered a “fiduciary” by law. See 40 Ill. Comp. Stat. § 5/1-101.2. A breach of a duty imposed by any Illinois statute causes that fiduciary to

be personally liable to make good to such retirement system or pension fund any losses to it resulting from each such breach, and to restore to such retirement system or pension fund any profits of such fiduciary which have been made through use of assets of the retirement system or pension fund by the fiduciary. . . .

Id. at § 5/1-114.

A firm could also be subject to penalties set forth in Illinois Blue Sky laws if that firm sells a prohibited security to a public entity or engages in a transaction with a public entity that is not permitted by statute. See id. at § 5/1-113.9.

Vigilance Remains Key to Avoiding Liability and Maximizing Value

Due diligence regarding existing statutes, ordinances, and other regulations is obviously key to avoiding liability and maximizing value. It follows that vigilance as to amended and new legislation is just as important. As recently as the drafting of this article, Pennsylvania and Colorado have revised their statutes in ways that affect how public funds and local government pension funds can be invested.

Taking effect in July 2019, Pennsylvania’s Act 5 inserted section 8411.1 into the Public School Employees’ Retirement Code. This new provision mandates that school district 403(b) and 457 plans retain a minimum of four separate financial institutions or pension management organizations to provide services for these plans. See 24 Pa. Cons. Stat. § 8411.1. Pennsylvania’s Public School Employees’ Retirement Code already required school districts to select a minimum of three investment option providers for school employees’ defined contribution plans. See 24 Pa. Cons. Stat. § 8411. Because the investment option providers required by section 8411 cannot overlap with the four financial institutions required by section 8411.1, a school district now must find four additional vendors to comply with Act 5. Unfortunately, this recent amendment may make affected retirement plans more costly for their beneficiaries.

Similarly, Colorado has recently amended its public fund investment provisions related to certificates of deposit and money market funds. The amendments clarify that negotiable certificates of deposit are considered investments, not deposits subject to the limitations of Colorado’s Public Deposit Protection Act. They also require money market funds to have an objective or investment policy to maintain a stable net asset value. While the certificates of deposit amendment expands the universe of available options for investment by public entities, the amendment related to money markets limits which money market funds may be considered by a public entity. These recent Pennsylvania and Colorado amendments highlight the importance of consistently reviewing state legislation related to public funds and pensions in order to maintain compliance with applicable laws.


To avoid a situation in which a firm could face liability for improperly advising a client in investing public funds, it is crucial for the firm to periodically review applicable statutes, regulations, ordinances, and policies governing the investment of public money. Developing a system of review for these types of accounts can go a long way in both maximizing returns for public entities and avoiding the potential for liability or loss of client trust.

Donald F. Winningham III is counsel and Kathryn B. Rockwood and Christy Boardman are associates with Bressler, Amery & Ross, P.C.

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