DEFINITION of Bearer Instrument
A bearer instrument, or bearer bond, is a type of fixed-income security in which no ownership information is recorded and the security is issued in physical form to the purchaser. The holder is presumed to be the owner, and whoever is in possession of the physical bond is entitled to the coupon payments.
BREAKING DOWN Bearer Instrument
Securities can be issued in two forms: registered or bearer. Most securities issued today are registered instruments. A registered instrument is one in which the issuing firm keeps records of a security's owner and mails out payments to him or her. The name and address of an owner of a registered security is engraved on a certificate, and dividend or interest payments can only be made out to the named security owner. To transfer ownership, the current owner must endorse the certificate which is presented to the issuer’s transfer agent. The transfer agent verifies the endorsement, cancels the certificate, and issues a new one to the new owner. The issuer, then, has a record of who owns the security and is able to make interest and dividend payments to the appropriate owner. However, it takes a while for a new security to be issued in another’s name.
An issuer of a bearer form security keeps no record of who owns the security at any given point in time. This means that the security is traded without any record of ownership, so physical possession of the security is the sole evidence of ownership. Thus, whoever produces the bearer certificate is assumed to be the owner of the security and can collect dividend and interest payments tied to the security. Ownership is transferred by simply transferring the certificate, and there is no requirement for reporting the transfer of bearer securities. Securities in bearer form can be used in certain jurisdictions to avoid transfer taxes, although taxes may be charged when bearer instruments are issued.
A bearer bond, also known as a coupon bond, is a negotiable instrument that has part of its certificate as a series of coupons, each corresponding to a scheduled interest payment on the bond. When an interest payment is due, the bondholder must clip off the coupons attached to the bond and present them for payment. For this reason, interest payments on bonds are referred to as coupons. The bearer of the bond certificate is presumed to be the owner who collects interest by clipping and depositing coupons semi-annually. The issuer will not remind the bearer of coupon payments.
Bearer instruments are used especially by investors and corporate officers who wish to retain anonymity, however, they are banned in some countries due to their potential use for abuse, such as tax evasion, illegal movement of funds, and money laundering. It has not been legal to issue bearer instruments in the U.S. municipal or corporate markets since 1982. Most jurisdictions now require corporations to maintain records of ownership or transfers of bond holdings, and do not permit bond certificates to be issued to the bearer. The only bearer instruments available in the secondary market are long-dated maturities issued before 1982, which are becoming increasingly scarce.