Request By:
Mr. Scheffel Wright
Assistant Director for Program Review
Legislative Research Commission
State Capitol
Frankfort, Kentucky 40601
Opinion
Opinion By: Robert F. Stephens, Attorney General; Martin Glazer, Assistant Attorney General
You seek the answer to several questions raised by the Committee for Program Review and Investigation concerning the Public Employees Deferred Compensation System (PEDCS) and its related administrative company, the Public Employees Benefit Services Corporation (PEBSC).
You ask:
"1. Under state law, can deferred compensation monies be invested in the common stock of a corporation?"
Kentucky Constitution, Section 177 provides:
"The credit of the Commonwealth shall not be given, pledged or loaned to any individual, company, corporation or association, municipality, or political subdivision of the state; nor shall the Commonwealth become an owner or stockholder in, nor make donation to, any company, association or corporation; nor shall the Commonwealth construct a railroad or other highway."
In two previous opinions, OAG 73-695 and 73-808, this very issue was raised, and this office advised that there was a possibility that investment in the stocks of a company by PEDCS might be in conflict with Section 177 of the Kentucky Constitution and that a declaratory judgment action should be maintained to resolve the issue. Apparently, this was not done. So, the issue is still to be resolved.
In
City of Louisville Municipal Housing Com'n v. Public Housing Administration, Ky., 261 S.W.2d 268 (1953), the question was raised as to whether the City of Louisville Housing Commission may insure its housing projects in a mutual fire insurance company. It was contended there that the Housing Commission is a state agency, that a mutual fire insurance company is a private corporation and that such a mutual insurance is owned by and shall be operated in the interest of its members and that by so purchasing mutual insurance, the agency was in violation of Sections 177 and 179 of the Kentucky Constitution [Section 179 forbids local subdivisions from investing in private companies in the same manner that Section 177 forbids the state from so investing. ]
The Court considered the history and purpose of Sections 177 and 179 of the Kentucky Constitution and quoted from
Hogan v. Kentucky Children's Home Society, 119 Ky. 235, 83 S.W. 605, 607, 67 LRA 815, to wit:
". . . . There was a time when the state was allowed to subscribe, and did subscribe, to the capital stock of various quasi public improvement companies, and loaned or gave its credits to such. It was to prevent a repetition of that practice by the state that the section was enacted." It is apparent that section 179 was enacted in order to place upon local governmental units the same general restrictions imposed upon the Commonwealth itself by section 177. The purpose behind both sections was to prevent local and state tax revenues from being diverted from normal governmental channels. The purpose will not be thwarted by the proposed action of the Housing Commission. None of the revenue of the Housing Commission is derived from local or state funds, and it has no authority to assess, levy or collect taxes in any form.
In order for this Court to hold that sections 177 and 179 prohibit the Housing Commission from insuring its properties in a mutual fire insurance company, we would have to read into those sections words which are not there. This we are not authorized to do." [Emphasis supplied]
This opinion was reaffirmed in
Louisville Board of Insurance Agents v. Jefferson County Board of Education, Ky., 309 S.W.2d 40 (1958).
Applying the rationale in those decisions to the facts here, the monies of the PEDCS do not come directly from tax funds, but are voluntarily assigned to it from employees of the Commonwealth, and there is no diversion of tax revenues from normal governmental channels by such investments. Like the governmental entities in the two aforesaid cases, the PEDCS has no authority to assess, levy or collect taxes in any form.
Thus, the answer to question #1 is "yes".
"2. Can deferred compensation monies be invested in mutual funds, whether backed by stocks or bonds?"
The aforesaid opinions specifically deal with mutual funds, and the
Court in Louisville Board of Insurance Agents v. Jefferson Board of Education, supra, stated at page 41:
"Another valid reason why membership in a mutual insurance company does not render the insured a stockholder of the company is because the policy merely fixes the legal status of the parties during the life of the policy. In no manner is there the same character of interests which a stockholder has in a stock insurance company. The privilege to vote, conferred by the policies in question, is merely incidental to acquiring the insurance protection being sought."
In short, the court held that becoming a "member" of a mutual company does not make the insured a "stockholder" within the meaning of Section 177 of the Kentucky Constitution.
So, for two reasons, the answer to question #2 is "yes".
"3. Could the Kentucky Employees Retirement System offer a deferred compensation plan to eligible employees?"
While the KERS could offer a plan, it could not be a deferred compensation plan under the Internal Revenue Code. The basis upon which taxes are deferred and not paid when the employee is paid his salary is that the money so deferred is paid directly to the PEDCS. The funds thus deferred are not the funds of the employee but that of the system. He only has a right to receive subsequent benefits under certain circumstances. The very fact that the monies at the time they are deferred are those of the system (the Commonwealth) makes them non-taxable at that time.
On the other hand, the funds of the KERS are those of the employee at the moment they are withheld for him (KRS 61.570; 61.692). Where the participation by an employee in PEDCS is voluntary, the participation of an employee in the KERS (except those who chose not to participate when his department first came into the KERS) is compulsory. The fact that the monies compulsorily deducted from the employee's pay in KERS is his from the moment of deduction makes such compulsory deductions constitutional.
Therefore, KERS could not offer a deferred compensation plan without a massive statutory change in its composition or without (statutorily) offering a separate fund which would meet federal requirements for consideration as a deferred compensation system.
"4. Could the Kentucky Employees Retirement System administer and offer a deferred compensation plan to employees wherein the amounts deferred (the employee's contributions) were invested in common stocks? "
This question has been answered in #3 and the answer is "no". KERS can invest in common stocks (and does so, KRS 61.650) but it would not be a deferred compensation plan.
"5. Could K.E.R.S. offer a plan wherein amounts deferred were invested in mutual funds? "
Based upon the answer to #3, the answer is "no".
"6. Could K.E.R.S. offer a plan wherein amounts deferred were invested in corporate bonds? "
Based upon the answer to #3, the answer is "no".
"7. Can the Deferred Compensation System offer deferred compensation plans directly to eligible employees wherein the amounts deferred by employees were invested in common stocks, mutual funds and corporate bonds? "
Based upon the answer to #'s 1 and 2, the answer is a qualified "yes". But in order to utilize such a method successfully, the PEDCS would need to market the product and would need to sell the product to the employees. This might require sanctioning of the sales material by the Securities Exchange Commission and registration with the Securities Dealers Association. The Department of Insurance would need to license those individuals selling the product as licensed insurance agents. So, while technically the PEDCS could provide the service directly, it could only do so after careful approval, registration and licensing of the persons involved by the various governmental agencies who have jurisdiction of such persons and subject matter.
"8. Could the Kentucky Employees Retirement System establish and offer annuity plans or contracts to participants directly, without the involvement of insurance companies?"
KERS could not offer a deferred compensation system without massive statutory changes, and with such changes it would face the same problem PEDCS would face in a direct marketing method.
"9. Can the Deferred Compensation System establish and offer annuity plans or contracts directly to employees?"
This question is governed by the answer to #7.
"10. If the answers to the foregoing questions concerning the Kentucky Employees Retirement System are no while the answers to analogous questions regarding the Deferred Compensation System are yes, may we generally conclude that the K.E.R.S. could assume the functions allowed to the Deferred Compensation System if appropriate statutory transfers of authority were made?"
If proper statutory changes were made, KERS could offer what is now offered by PEDCS.
"11. Kentucky Revised Statutes, Section 18.510 defines 'employee'. Section 18.540 (7) (f) allows the Deferred Compensation System Board of Trustees to make all rules and regulations not inconsistent with the provisions of KRS 18.510 to 18.600. Can the Board, using its rule-making authority, adopt a narrower definition of 'employee' than set forth in Section 18.510? Specifically, could the Board adopt the same definition of 'employee' as that used by the K.E.R.S.?"
We do not believe the board of PEDCS can, by regulation, reduce the term "employee" inconsistently with the definition of the term in the statute. Otherwise, the regulation would have the effect of amending the statute. An administrative agency has only those powers granted to it by the statute creating it.
"12. Can the Board by rule clarify the status of groups where it is ambiguous under Section 18.510?"
Providing the clarification does not, in effect, amend the statutory definition, such clarification may be authorized where it merely interprets and actually clarifies a statutory definition.