When governments issue bonds they deposit the bond proceeds (and occasionally other monies) in various funds, which may include a construction fund, debt service fund, capitalized interest fund, debt service reserve, or in the case of a refunding, an escrow fund. In some cases these funds may be held by a third party trustee. Monies allocated to these funds usually are invested until needed. The investment strategy for each fund will depend, in part, on federal or state statutes and regulations governing the types of instruments permitted to be used for the investments, the arbitrage yield permitted for the fund, requirements from rating agencies and/or credit enhancement providers, and the anticipated drawdown of bond proceeds. Additionally, each of these funds will have different investment objectives, so there are many factors that must be considered by the government when selecting the investment instrument. Governments need to be mindful that cash flow analyses are critical components of the process and are useful in reducing the possibility of negative arbitrage that may occur. Furthermore, the presence or lack of arbitrage could affect the entire structure and sizing of the debt financing.

Due to the Dodd Frank Act and the Securities and Exchange Commission’s (SEC) Municipal Advisor Rule (the “Rule”), brokers may be considered municipal advisors if they provide advice on investments of bond proceeds to governments. Under the Rule, municipal advisors have a fiduciary duty to their government clients, and, if brokers wish to avoid becoming fiduciaries, they will be unable to provide advice to government clients unless they meet one of the exemptions to the Rule, which are described in this section. Broker-dealers will be deemed to have provided “advice” when they make a recommendation to their government clients to buy a particular security. However, brokers may provide certain information without it being considered advice.
For example, the SEC has said that brokers may provide information about their firm’s currently available investments (e.g., the terms, maturities, and interest rates at which the firm offers these investments) or price quotes for investments available for purchase or sale in the market that meet criteria specified by a municipal entity. This is considered general information and therefore is not considered advice. Also, a broker may respond to requests for offers for investments of bond proceeds and escrows as long as the broker is just quoting a price and not otherwise commenting on the advisability of those investments.

There are also two exemptions that will allow a broker to provide advice without becoming a municipal advisor with a fiduciary duty. The first is the RFP exemption. Under this exemption an issuer could send out an RFP for investments to at least 3 reasonably competitive providers, asking for recommendations on how it should invest bond proceeds for a particular period of time. The broker could respond to that RFP by providing advice on which investments are good candidates for the issuer. A form of RFP document that would satisfy this exemption, along with model language for the other exemptions in the Rule, is available in the GFOA MA Rule Alert, which is linked to in the reference section of this document. A definition of the term Municipal Advisor can also be found in the Alert.

There is also an exemption if the issuer has an independent registered municipal advisor (IRMA) that will provide it with advice on investments. It requires a written representation on the part of the issuer and a corresponding disclosure on the part of the broker to both the issuer and the municipal advisor. A form of an issuer IRMA representation and a form of broker required disclosure is also available in the GFOA MA Rule Alert. Note: A government may not use an SEC-registered investment adviser as its IRMA, because SEC-registered investment advisers are exempt from the definition of “municipal advisor.” Additional resources to help governments become familiar with the Rule are included in the References section of this Best Practice.

There is also an exemption if the issuer has an independent registered municipal advisor (IRMA) that will provide it with advice on investments.  It requires a written representation on the part of the issuer and a corresponding disclosure on the part of the broker to both the issuer and the municipal advisor.  A form of an issuer IRMA representation and a form of broker required disclosure is also available in the GFOA MA Rule Alert.  Note: A government may not use an SEC-registered investment adviser  as its IRMA, because SEC-registered investment advisers are exempt from the definition of “municipal advisor.”  Additional resources to help governments become familiar with the Rule are included in the References section of this Best Practice.


The Government Finance Officers Association (GFOA) recommends that state and local governments develop an understanding of the risks inherent in investing bond proceeds and incorporate steps in their investment strategy for each fund to minimize these risks. Three types of risk are: (1) credit risk (safety), the risk of investing in instruments that may degrade in credit quality or default; (2) market risk (liquidity), the risk of selling an investment prior to maturity at less than book value; and (3) opportunity risk (yield/return), the risk of investing long term and having interest rates rise or investing short term, having interest rates fall and needing to reinvest the bond proceeds.

Issuers should consider actions to mitigate these risks. These actions include establishing guidelines for permitted investments to reduce credit risk, developing good cash flow estimates and periodically updating those estimates to reduce market risk, and integrating knowledge of prevailing and expected future market conditions with cash flow requirements to reduce opportunity risk. As with investment decisions made with other public funds, the balance generally is weighted heavily towards the preservation of capital (avoiding risk), maintaining liquidity second, and yield last.

Provided that the maximum allowable arbitrage yield can be earned, state and local government series securities (SLGS) generally are the recommended investment option rather than utilizing open market securities for escrows accounts for refunding bonds. The benefits of SLGS include better matching of debt service payment dates on the refunded bonds and fewer arbitrage rebate issues for borrowers. One cautionary point, however, is that issuers need to be aware of times when the federal government stops selling SLGS and discuss with counsel and/or their municipal advisor or investment adviser an alternative investment strategy for the escrow account.

GFOA also recommends that governments develop specific policies and procedures for the investment of bond proceeds to ensure that legal and regulatory requirements are met, fair market value bids are received, and issuer objectives for various uses of proceeds are attained. Governments should also have in place policies and procedures for when they will engage the use of an investment adviser or municipal advisor. Governments that may not have dedicated staff to closely monitor markets and their investments are strongly encouraged to use a municipal advisor or investment adviser.

Investment of bond proceeds should include an evaluation of investment alternatives including: (1) individual securities or portfolio of securities; (2) investment agreements; and (3) mutual or pooled investment funds, including money market funds. The following actions are recommended as part of the evaluation of investment alternatives:

1. A government should have an investment policy which is disclosed and summarized in the Official Statement and which includes the investment of bond proceeds or describes other documents that outline the parameters for investment of bond proceeds. A government should comply with its investment policy or document and explain the reasons(s) for any deviation from the policy.
2. The government should coordinate its debt management and investment of bond proceeds activities, especially if different offices and staff are involved in each task. Governments should be aware that different types of bonds proceeds may have varied investment goals and procedures.

3. The government should understand its interactions with brokers-dealers regarding the investment of bond proceeds and escrows may change as a result of the new MA Rule described above. Many broker-dealers will likely be unwilling to provide advice, which would subject them to a federal fiduciary duty. Some broker-dealers may clarify that they will not provide advice absent an exemption from the MA Rule (as described above), but will instead only show the government their inventory, quote prices and respond to requests for offers. Some broker-dealers may refuse to accept accounts with bond proceeds or escrows.

4. If investments are longer than one year, mark to market accounting requirements should be in place, which can be verified by external auditors.

5. The duties of the individual designated by the government to be responsible for the investment of bond proceeds (internal or external personnel, which could be the investment officer) should be specified and include the management and ongoing monitoring of the following:

  • Work with the municipal advisor or investment adviser, bond counsel, and other consultants, to determine how bond proceeds will be invested given expectations for the drawdown of proceeds, federal tax law requirements, or other concerns;
  • Make certain that the drawdown of proceeds is planned and recorded and that the investment duration is shorter than the expected drawdown schedule. Since the draw schedule may change over time, it should be periodically revisited;
  • Ensuring that fees paid to brokers are reasonable and are within internal policy and federal guidelines;
  • Regular and ongoing monitoring of investment and custody of bond proceeds;
  • Reinvestment of bond proceeds when necessary;
  • Governments should ensure that they review their investment policy to ensure compliance when the investment of bond proceeds may span several years;
  • Understanding federal tax law, particularly as it pertains to arbitrage restrictions;
  • Providing periodic reporting of investment results; and
  • Maintaining adequate records to comply with arbitrage reporting and rebate requirements.

6. The identified personnel, working with the investment officer, debt manager or where applicable, outside professionals,  must ensure that investment decisions conform to all legal, statutory, and regulatory requirements, all requirements established by the trust indenture/bond resolution or fiscal agent agreement, and all requirements that might be imposed by rating agencies and/or credit enhancement providers, including:

  • Establishment of funds and accounts;
  • Designation of eligible investment instruments;
  • Credit risk should be very low
  • Final maturity dates should be the focus rather than call dates or expected maturity dates
  • Purchase of investments at fair market price;
  • Permitted yields, such as those to comply with federal arbitrage requirements (outside professionals should be hired to ensure accurate arbitrage reporting and compliance); and
  • Monitoring of arbitrage rebate liabilities and establishment of procedures to reserve liabilities for future remittance to IRS.

7. An issuer should require that municipal advisors and investment advisers report any finder’s fees or fee-sharing arrangements. The issuer should evaluate any other potential conflicts of interest. As a general matter, there should be no fee sharing or finder’s fee arrangement. If, in fact, these arrangements occur, issuers should require that municipal and investment adviser report this information to them in advance of any such arrangement.

8. An issuer should seek competitive bids and, where required, a minimum of three bids. Additionally, an issuer should require that all fees associated with investments be fully disclosed to ensure that investments are being purchased at a fair market price. Issuers should document that they are getting a fair market price on the investments from those bidding on the investment of the proceeds.. In many cases, the IRS requires three bids from parties not related to the transaction. Furthermore, to allow for brokers-dealers that do not have a fiduciary duty to the issuer to place a bid, the SEC requires that the issuer that wants to create the RFP exemption from the definition of “municipal advisor” have widely disseminated its call for bids to at least three parties. Records should be maintained to document that investments were purchased at a fair market price. The issuer also should ensure that the bids are date stamped and arrive at the same time. It is important to note that the IRS has implemented enforcement action over the years regarding professionals that have misled or manipulated the bidding process, noting that issuers should be extra cautious and implement appropriate policies to help ensure that the bidding process is conducted properly and fairly.

The specifications of the request for proposals for purposes of obtaining competitive bids are described in more detail in the GFOA MA Alert referred to below. GFOA recommends obtaining a minimum of three competitive bids.

9. Extreme care and due diligence should be taken to guarantee that the interests of the issuer are represented if outside professionals are used to solicit and evaluate bids. This generally is best accomplished through the use of competitive request for proposal processes to select the necessary outside financial professionals.