An Overview of Regulations Governing the Management of Public Funds

Organizations supported by tax dollars are understandably held to stringent fiscal regulations that dictate how funds are collected, invested, and used. These standards are set by various regulatory bodies, and they serve to maintain public trust.

However, the complexity of the regulatory landscape makes identifying every applicable rule a daunting task and complying with them even more tedious. The following overview of investment regulations impacting municipalities, school districts, and other public entities provides a starting point for investment managers at these organizations.

Federal Regulations Govern Bond and Grant Proceeds

The federal government generally does not dictate which investments a public entity can utilize but instead focuses on the outcome of those investments. Two particular areas of interest are the amount of investment income allowed for proceeds of tax-exempt bonds and the allowable returns on money from federal grants.

Arbitrage and Rebate Rules for Tax-Exempt Bonds

When a municipality or school district issues a tax-exempt bond, they must monitor the amount of interest earned by investing bond proceeds relative to the amount paid to bondholders. Arbitrage occurs when the issuing entity earns more from investing the proceeds than it pays to bondholders.

Section 148 of the Internal Revenue Code and Treasury Regulations impose strict limitations on the instances when arbitrage is acceptable and when it is not. These are known as “yield restrictions”, and they are one of the most important regulations that bond issuers need to understand.

In most cases, bond issuers are not permitted to earn more than they pay to bondholders, otherwise known as profiting from a bond or “borrowing to invest.” If they do, they must pay the excess interest to the Internal Revenue Service [IRS] as a “rebate” to retain the tax-advantaged status of their bonds.

OMB Uniform Guidance for Federal Grants

Municipalities and school districts that receive federal grants – such as Title I funds for schools or infrastructure grants for cities – are subject to the Office of Management and Budget [OMB] Uniform Guidance. These rules govern financial management, procurement, and reporting standards for public entities, and those entities must follow the guidelines in order to continue receiving federal grant money.

The Uniform Guidance was first released in 2014, and combined previous federal grant management guidance into one comprehensive set of rules. Since that time, it has been updated twice, with the most recent changes occurring in 2024.

OMB rules cover several financial aspects for public entities receiving grant money, including:

• Financial Management. Standards for internal controls and accounting systems to track the uses of federal funds.
• Procurement. Specific rules for purchasing goods and services to prevent waste, fraud, and favoritism.
• Administrative Requirements. Outlines the grant lifecycle from initial application to closing of the award.
• Cost Principles. Defines the criteria for “allowable,” “allocable,” and “reasonable” expenses, ensuring that federal funds are only used for the stated purpose.
• Audit Requirements. Mandates that non-federal entities spending $1 million or more in federal awards per year undergo a “Single Audit” to ensure compliance with program requirements and financial integrity.

These strict guidelines ensure that federal awards are used in a timely manner for their intended purpose. In other words, federal funds are being used – not invested for profit.

However, §200.305 of the Uniform Guidance states that a public organization is generally expected to store federal money in an interest-bearing account, though the organization is only permitted to keep up to $500 in interest earned per year. The remainder must be returned to the Department of Health and Human Services Payment Management System [PMS].

State Statutes Provide Additional Guardrails for Public Fund Management

State regulations are generally more specific than the federal guidelines and aim to ensure that public organizations invest safely. The rules vary by state, but they generally specify the types of investments permitted and the amount of collateral required to keep funds safe.

In Wisconsin, for example, a public entity can invest in:

• Time deposits, such as Certificates of Deposit, from a credit union, bank, or similar financial institution.
• Government securities, including Treasuries and specific types of municipal bonds.
• Highly-rated debt securities that mature within 7 years.
• Mutual funds and similar investments that do not charge a sales load and consist of bonds or repo agreements that are fully collateralized.

This list is not exhaustive, and there are nuances that must be considered with each type of investment mentioned. Fortunately, the same statute also allows public entities to partner with certain types of financial firms for guidance and support when choosing appropriate investments.

Investment Partners: The Importance of an MSRB-Registered Advisor

The Municipal Securities Rulemaking Board [MSRB] consists of representatives from the public and entities regulated by the board. Their goal is to strengthen the municipal securities market and protect public interest. One way they do this is by licensing and overseeing specialized advisors that manage cash or investments on behalf of public organizations.

Registered municipal advisor firms must have at least one municipal advisor representative who has passed the Series 50 exam and one municipal advisor principal who has passed the Series 54 exam. The firm must also register with both the Securities and Exchange Commission [SEC] and the MSRB.

Further, registered municipal advisors are held to a federal fiduciary duty under MSRB Rule G-42. This duty includes a legal requirement to make suitable recommendations based on the needs of the client rather than any compensation that the advisor might earn.

With a fiduciary duty, strict education requirements, and oversight from both the SEC and MSRB, public organizations can have confidence in the abilities of a registered municipal advisor to make recommendations regarding their investments. A partnership with the right municipal advisor can reduce the complexity of meeting compliance standards while helping to achieve safety and liquidity requirements.

Partner with ADM for Public Fund Management and Follow Us for More Valuable Insights

At American Deposit Management, we publish weekly articles on the most impactful topics in business, banking, and public fund management. Follow us on LinkedIn and subscribe to our mailing list to have our insights delivered straight to your inbox.

We also help public entities manage their cash reserves to meet compliance regulations and the needs of the public they serve. Our organization is a MSRB-registered municipal financial advisor, and we manage just under $1 billion for more than 275 government and municipal clients.

As a fiduciary, we offer access to low-risk investments through a vast network of pre-screened, pre-approved, well-capitalized banks and credit unions. Our solutions provide access to full FDIC / NCUA insurance or collateralization for liquid accounts and Certificates of Deposit according to applicable state statutes.

To learn more and get started, contact a member of our team today.

BACK