shutterstock/Michelle Milano

Bearer bonds are owned by whoever physically holds them, rather than through the registered ownership system used for the majority of securities. Similar to other bonds, they have a stated maturity date and interest rate, but bearer bond coupons for interest payments are physically attached to the security and must be submitted to an authorized agent for payment. In this way, bearer bonds are different from other bonds, which are no longer physically issued, existing only on the computerized records of brokers and custodians

In the 20th century, this ease of ownership transfer and its characteristic anonymity were 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

Bearer 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 these bonds could be issued in very large amounts using relatively few certificates (sometimes in the tens of millions of dollars) made them preferable to stacks of cash or other negotiable financial instruments in the conduct of transactions. Europe and the remainder of the Americas adopted the use of these bonds in their own financial systems for similar reasons. (For a closer look at the evolution of the bond market in the 20th century, read The Bond Market: A Look Back.)

Bearer bonds are also called coupon bonds because the physical bond certificates have coupons attached to them, redeemable at an authorized agent for biannual interest payments in an activity that is commonly called "clipping coupons." (For more insight, read How Does the Money From the Interest on My Bond Get to Me?)

The Risks of Bearer Bonds

There is no registered owner's name printed on the face of a bearer bond, historically allowing interest and principal to be paid without question to anyone tendering a bond certificate. Prior to 2010 restrictions, the holder of a bearer bond need only submit certificates to the issuer's agent at the maturity date to anonymously cash them for face value. This was expeditious but also generated great risk for the legitimate owner because, if  lost or stolen, there was no way to trace interest or principal payments or to prove the rightful beneficiary.

Unlisted or unrated bonds issued in bearer form also carried risk that interest and principal payments were guaranteed only by the good faith of the issuer. Given the long life of some bearer bonds, the possibility an issuer might not honor the promise to pay at maturity increased over time. 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

Bearer bonds have historically been the financial instrument of choice for money launderers, tax evaders and others 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), author F. Scott Fitzgerald has his mysterious main character involved in a scheme to sell bearer bonds of questionable origin. In the popular late 20th century movies Beverly Hills Cop, Die Hard and Heat, villains steal millions of dollars in bearer bonds while misleading the heroes into thinking the object of their illegal activity is a different target. (Read more about the movie industry's take on Wall Street in Financial Careers According to Hollywood.)

The use of bearer bonds to avoid taxation became more popular after World War I. Illegal activity involving bearer bonds continued in the following decades until the Tax Equity and Fiscal Responsibility Act of 1982, which outlawed new issuance of bearer bonds in the United States. These days, eurobonds are still issued as electronic 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. (For more on T-bonds, read Basics of Federal Bond Issues.)

The Future of Bearer Bonds

Most bearer bonds in circulation today were issued when interest rates were relatively high. As a result, many were called before their maturity dates in order to reduce carrying costs to the issuers. Current redemptions have become nearly non-existent due to a 2010 law that relieved banks and brokerages of their redemption responsibility. Then, two years later in 2012, many paper certificates still in circulation, housed at the Depository Trust Company (DTC), were destroyed during Superstorm Sandy.

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, with the information 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, most bonds issued these days are stored in electronic form in brokerage accounts and interest payments are automatically calculated, paid and reported to the tax authorities. (Learn more about the role of a brokerage in Brokerage Functions: Underwriting and Agency Roles.)

If you are the holder of bearer bonds, you may find there are only a few banking agents that will cash your coupons and you may have to send them to a processing center to get paid. Even if you 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 (you would not have been notified in advance due to the absence of registration information), 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. (Learn more about call features in Call Features: Don't Get Caught off Guard.)

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. However, these 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 nearly extinct.

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