Bond deals to feel weight of Texas AG's anti-DEI legal opinion

University of Chicago Harris School of Public Policy

In the wake of Texas Attorney General Ken Paxton's sweeping legal opinion that said state and local government diversity, equity, and inclusion laws or practices giving preferences based on sex or race are unconstitutional, the head of his office's public finance division put bond issuers on notice.

A Jan. 20 advisory to bond counsel from Assistant Attorney General Leslie Brock indicated state and local issuers' use of programs and bond financing statutes involving minority- and women-owned business enterprises in their bond deals needs to be disclosed when seeking the office's approval for the debt, which is required under Texas law.

Starting Monday, "issuers must provide certification confirming that bond proceeds will not be used for any unconstitutional purposes, including payments made pursuant to unconstitutional DEI programs and including any such DEI programs established by local ordinances or policies," the advisory said. 

Percentage goals or requirements for MWBE participation in debt issues were deemed unconstitutional in the opinion, Orrick public finance attorneys said in an article posted on the law firm's website on Friday.

Paxton called the opinion, released on the Jan. 19 Martin Luther King Jr. federal holiday, "the most wide-sweeping, binding legal document" since the U.S. Supreme Court's 2023 decision ending affirmative action in higher education and that the dismantling of DEI helps fulfill the civil rights leader's vision. 

In his third term as attorney general, Paxton is running for U.S. Senate against incumbent John Cornyn, who questioned assertions in the opinion in a social media post and said his opponent was "showboating for attention."

Legal experts and the Republican attorney general's own website point out that the office's opinions do not carry the force of law. An explanation on the website states an opinion "is a written interpretation of existing law" and cannot create new provisions or correct "unintended, undesirable effects" in a law, adding the constitutionality of a law is decided by courts.

Justin Marlowe, director of the Center for Municipal Finance at the University of Chicago's Harris School of Public Policy, said Paxton's opinion is "by far the most municipal bond market-specific steps to this effect" he has seen. 

"It wouldn't be the least bit surprising if you saw AGs sort of do something similar to this, recognizing that it may or may not get traction in the state legislature, but that this is something that an AG can move the needle on," he said.

An opinion by Republican Florida Attorney General James Uthmeier that was also released Jan. 19 said state laws requiring race-based action, including goals for minority and women business participation in government contracts, to be unconstitutional and that his office "will not defend or enforce any of these discriminatory provisions."  

Both Paxton's opinion and Texas Acting Comptroller Kelly Hancock's action in December removing MWBEs from preferences for state contracts under a renamed Historically Underutilized Business program make exceptions for veteran-owned and operated businesses.

Rudy Mejia, a West Point graduate and former U.S. Army captain who heads Austin-based municipal advisory firm Nickel Hayden Advisors, said the opinion shifts access from MWBEs to firms like his own.

"But at the end of the day, I know Nickel Hayden's never been hired because we are a veteran-owned firm," he said. "We've been hired because we have the issuers' trust, and they clearly see how well we execute."

He added that issuers "are very risk adverse" and guidance from the attorney general office will drive policy changes. 

After the release of the opinion, the Texas Bond Review Board removed from its debt issuance guidelines a requirement for state issuers "to make a good faith effort to achieve 33% participation by historically underutilized business firms in the underwriting and issuance of debt."

Facing the potential loss of hundreds of millions of dollars in federal grants under Trump Administration efforts to weed out DEI, Dallas and Fort Worth last year ditched their MWBE-related programs.

In December, Dallas rescinded a 2020 MWBE policy and adopted a small businesses enterprise policy, according to a city spokesperson.

The previous Business Inclusion and Development policy set a 38% goal for MWBE participation in professional services contracts. The city suspended sex and race-based policies in June to comply with federal directives.

Fort Worth created a Small Business Development Program, which it said "reflects the city's commitment to strengthening Fort Worth's business ecosystem and aligns with federal grant guidelines and community feedback."

An Aug, 5 statement from the city said grant recipients are required to certify they don't use race, sex, or religion criteria and that "noncompliance would result in loss of federal funding, civil and criminal liability for city employees and the city being required to repay up to three times the grant amount."

In a statement last week, Houston City Controller Chris Hollins said the city "selects underwriters, bond counsel, and financial advisors based on qualifications, performance, and value to taxpayers — nothing more, nothing less."  He also said narrowing the pool of qualified firms weakens competition and ultimately increases costs.

Dallas Independent School District, which is considering asking voters this year for as much as $6.24 billion in future debt, has a Small Business Enterprise policy that is race and gender neutral, according to Chief Financial Officer Eduardo Ramos.

Municipal bond underwriters have been in the crosshairs of Texas' culture wars previously with the enactment in 2021 of laws banning state and local government contracts worth $100,000 or more with businesses that "boycott" or "discriminate" against the fossil fuel or firearm industries. 

As a result of the two laws, Barclays, UBS, and Citigroup were banned from muni underwriting in Texas, with the latter two announcing plans in 2023 to shrink or end their muni operations nationwide.

Major investment banks survived a review Paxton launched in 2023 over their membership in the Net Zero Alliance in potential violation of the fossil fuel boycott law. As of Jan. 7, 2025, Bank of America and JP Morgan remained on review under the firearm industry discrimination law.   

The fossil fuel law is being challenged in federal court, where a judge held oral arguments in June on cross motions for summary judgment. The case, brought by the American Sustainable Business Council against Paxton and then-Texas Comptroller Glenn Hegar, claimed the law violates free speech and association rights protected under the First and Fourteenth Amendments of the U.S. Constitution.

The complaint also pointed to a Texas Association of Business study that found less competition in the municipal bond market for Texas debt as a result of the two laws "is leading to higher interest costs, which in turn increases the debt burdens of local governments, straining resources and levying additional costs on Texas taxpayers."