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Bearer Bonds: From Popular To Prohibited

Guy Bernfeld

Bearer bonds are bonds that are owned by whoever is holding them, rather than having registered owners like most other securities. Like most other bonds, they have a stated maturity date and interest rate, but coupons representing interest payments are generally physically attached to the security and must be submitted to the company for payment. In this way, bearer bonds are different from most other bonds, which aren't physically issued anymore, but instead exist on the computerized records of brokers and custodians.

Why would an investor choose this unusual instrument? One reason that an investor might choose to receive a bearer bond certificate is because it is a very easily negotiated debt instrument. However, in the 20th century, that ease of ownership transfer and the characteristic anonymity afforded holders of bearer bonds were very often exploited to evade taxes or conceal business transactions. In response, new issuances of bearer bonds were banned in the United States in 1982. Read on to learn more about the past, present and future of this once-popular investment vehicle.

A Short History of Bearer Bonds

B earer bonds were most likely first used in the United States during the post-Civil War era to fund Reconstruction (1865–1885). Ease of transfer and the fact that these bonds could be issued in very large amounts using relatively few certificates (sometimes in the tens of millions of dollars) made bearer bonds preferable to using stacks of cash or some other negotiable financial instrument in the conduct of transactions. Europe and the remainder of the Americas adopted the use of these bonds in their own finance systems for similar reasons of utility.

Bearer bonds are also called coupon bonds because the physical bond certificates have coupons attached to them that can be redeemed at an authorized agent bank for biannual interest payments, an activity that is commonly called "clipping coupons."

The Risks of Bearer Bonds
Because there is no registered owner's name printed on the face of a bearer bond, interest and principal will be paid without question to anyone tendering a bond certificate. The fact that the holder of a bearer bond need only submit certificates to the issuer's agent at the maturity date to anonymously cash them in for their face value might be expeditious, but it also creates great risk for the legitimate owner. If they're lost or stolen, there is virtually no way to trace interest or principal payments or to prove who the rightful beneficiary is. In that case, as there was no registration, the holder who should have been entitled to the proceeds is pretty much out of luck.

Unlisted or unrated bonds that are issued in bearer form can also carry the risk that interest and principal payments may in some cases be guaranteed only by the good faith of the issuer. Given the long life of some bearer bonds, the possibility that an issuer may not be around to make good on its promise to pay at maturity can increase over time, and pursuing one's right to payment in the courts would mean surrendering the anonymity of ownership that was probably the holder's intent in the first place. In one famous case in the late 1920s, German banks backed by provincial governments and the government of Prussia issued tens of millions of dollars in bearer bonds, ostensibly as part of a program to improve Germany's agricultural sector. The bonds were to mature in 1958 and were payable in New York, but to this day neither the interest nor the principal has been paid.

Criminal Uses of Bearer Bonds

As mentioned, bearer bonds have historically been the financial instrument of choice for money launderers, tax evaders and those just generally trying to conceal business transactions.

The theft and illegitimate use of bearer bonds has been the premise of book plots and Hollywood movies for years. In "The Great Gatsby" (1925), which is set in the 1920s, author F. Scott Fitzgerald has his mysterious main character involved in a scheme to sell bearer bonds of questionable origin. In popular modern movies like "Beverly Hills Cop," "Die Hard" and "Heat," the villains are out to steal millions of dollars in bearer bonds while misleading the heroes into thinking the object of their illegal activity is some other target.

The use of bearer bonds for avoiding taxation became more popular after World War I, and illegal activity involving bearer bonds continued over the following decades until various nefarious criminal activities involving bearer bonds resulted in the Tax Equity and Fiscal Responsibility Act of 1982, which outlawed any new issuance of bearer bonds in the United States. These days, eurobonds are still issued as bearer bonds, and U.S. corporations are able to issue their bonds into the European market in that form . It's interesting to note that in 1985, during a period when the federal deficit was soaring to new heights, the issuance of U.S. Treasury bonds in bearer form to non-U.S. residents was legalized, in effect creating a tax haven for foreigners buying U.S. debt.

The Future of Bearer Bonds
Most bearer bonds in circulation today were issued when interest rates were relatively high. As a result, over the years, many of them were called before their maturity dates in order to reduce the carrying costs to the issuers. There are U.S.-issued bearer bonds still in circulation because of their long lifespan - up to 50 years - but, according to an article that appeared in The New York Times on February 13, 2006, by 2013 most of these bonds will have become extinct.

The New York Times also revealed that the Depository Trust Company (DTC), one of the world's largest securities depositories, has only a relative handful (compared to previous numbers) of employees working to clip coupons, redeem them and transfer the proceeds to brokers who credit their customers' accounts. Compare that to 1991, when the company was responsible for handling 21 million bearer bonds, or 42 million coupons, a year and employed 600 people to do it. Because no new bearer bonds are being issued, the number of bonds in the DTC vault has fallen to below 700,000, about $3.5 billion worth, not including interest.

In order to locate the owners of currently outstanding bearer bonds, it is now required that anyone depositing coupons must furnish a name, address and Social Security number to the bank at the time of each deposit. The information then becomes instantly available to the IRS. While it can be said that endorsing the back of a check or other financial instrument without designating a new payee creates a bearer security, these days most bonds are issued and stored in electronic form in brokerage accounts, and interest payments are automatically calculated, paid and reported to the tax authorities.

If you are the holder of bearer bonds, you may find that there are only a few banking agents still around that will cash your coupons, and you may have to send them to a processing center to get paid. Even if you do find an agent who is willing to work with you, you may discover that interest payments on your bonds have stopped because the issuer called the bond well before the maturity date.

Even if your bond has been called early (due to the absence of registration information, you would not have been notified of the fact in advance), you may still be entitled to a portion of its face value in accordance with the original call feature of the bond. In any case, you should contact the issuer or the issuer's agent to arrange payment.

The Bottom Line
Bearer bonds are easily transferable, easily negotiable and anonymous, and in certain circumstances, they have distinct advantages over other forms of currency, such as cash. However, these same advantages have been misused to cover up criminal activity or otherwise circumvent the law. As a result, the future of bearer bonds is uncertain, with U.S.-issued bonds to become nearly extinct in the years to come and payment being uncertain even for those still in existence. If you currently hold bearer bonds, it may be advisable to check with the issuer for updated information on the status of your bonds.

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