California’s IOU’s (Updated)
As has been widely publicized cash-strapped California has decided to temporize on its budget impasse by issuing IOU’s to creditors. This brings up an interesting question.
Article I Section 10 of the U. S. Constitution states:
No state shall enter into any treaty, alliance, or confederation; grant letters of marque and reprisal; coin money; emit bills of credit; make anything but gold and silver coin a tender in payment of debts; pass any bill of attainder, ex post facto law, or law impairing the obligation of contracts, or grant any title of nobility.
California’s IOU’s sound very much like bills of credit. Regardless of the prudence of the state of California’s decision, is it violating the law?
There’s another wrinkle in this story. There’s an SEC Staff Statement to the effect that the California IOU’s are securities under federal law and those who purchase them are protected by the anti-fraud provisions of federal security law:
The staff of the Securities and Exchange Commission has expressed its belief that California’s recently-issued IOUs are “securities” under federal securities law. As such, holders of these IOUs and those who may purchase them are protected by the provisions of the federal securities laws that prohibit fraud in the purchase or sale of securities.
California began issuing the IOUs (called “registered warrants” by California) on July 2 to certain individuals and entities, including citizens who were entitled to a tax refund or vendors who were entitled to payments. The IOUs are obligations of the State of California, are negotiable, and bear interest. The staff’s view that the IOUs are securities does not affect California’s right to issue or repay the IOUs.
In addition to the antifraud provisions of the federal securities laws, other parts of the federal securities laws also apply to the purchase and sale of the IOUs. Persons acting as intermediaries between buyers and sellers of the warrants may need to register as brokers, dealers or municipal securities dealers, or as alternative trading systems or national securities exchanges.
Broker-dealers, as well as any potential secondary markets, should be aware that the requirements of the securities laws and the rules of the Municipal Securities Rulemaking Board apply to the IOUs.
Finally, although the IOUs are labeled “registered warrants,” they are not registered with the SEC. There is no registration requirement that applies because the IOUs are municipal securities.
I interpret this as mostly affecting the secondary market and having little to do with the question I raised in the body of the post.
The image above is a fragment of a one shilling bill of credit issued by the North Carolina Colonial Assembly in 1754.