Investment of Public Funds - Liability for Violations of Statutes re Investment of Public Funds

Financial Institutions Law Alert

 

As discussed in our previous alert on this topic, there are numerous pitfalls inherent in advising clients charged with investing public funds. Consulting for or managing these accounts requires compliance with a complexity of state and local statutes, regulations, and ordinances in addition to the investment policy adopted by the board of the public entity itself. These regulatory schemes provide a plethora of opportunities for misstep and non-compliance that, in some cases, can lead to liability on behalf of the firm.

For example, a firm working with an entity responsible for the investment of public funds in Colorado could face liability in several scenarios. First, if a firm “sells or causes to be sold” an investment to a public entity not permitted by statute governing permissible investments and “who knew or should have known that said investment was not a lawful investment”, the firm could face liability for “any loss of investment principal resulting from the investment” as well as “any reasonably foreseeable costs resulting from such loss, including attorney fees” plus interest. Similarly, a firm that sells a financial instrument to a public entity that fails to comply with the statute may be compelled to repurchase such instrument for the greater of the original purchase price or the original face value, plus any accrued interest. Simply stated, a firm selling investments to a public entity or assisting a public entity in choosing investments could face liability if the recommended investment does not comply with the Colorado statutes.

In other contexts, liability depends on whether (1) an investment adviser/consultant or investment manager is considered a “fiduciary” under a particular state’s statutory scheme or the investment policy of a particular public entity or (2) exercises discretion over the investment of the public monies. For example, in Illinois, a firm that sells a security to a public entity or engages in a transaction with a public entity that is not permitted by statute could be subject to the penalties set forth in the Illinois Blue Sky law. Moreover, any person that is a fiduciary that breaches any duty imposed by the Illinois statutes is personally liable “to make good any losses resulting from each such breach, and to restore to the fund any profits of such fiduciary which have been made through the use of assets of the fund by the fiduciary, . . . .” So, the particular role a firm accepts in assisting a public entity can determine whether the firm could potentially face liability for any missteps along the way.

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