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Clarity Needed on Individual Surety Assets

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ENR's recent special report on individual surety suggests that an overhaul of individual-surety asset rules is needed now more than ever. The Security in Bonding Act, which passed the House last year but died in the Senate, has been resubmitted to the House by Rep. Richard Hanna (R-N.Y.), and Congress soon will have another chance to make certain that surety guarantees pledged on federal projects are backed by legitimate, easy-to-verify assets.

The U.S. has seen enough mystifying complexity in securities in recent years to learn that, in financial matters, transparency is a necessity, not just a virtue.

One part of Rep. Hanna's proposed legislation would increase the federal government's guarantee under the Small Business Administration's surety-bond guarantee program. Recent revisions to the SBA program have tripled the eligible amount, to $6.5 million from $2 million, that SBA will guarantee. Any additional flexibility should help make bonds available to more small and minority contractors.

The bill would require any individual surety to pledge very specific assets, such as a Treasury bill or a similar instrument, and place them under the control of a government entity. This pathway would eliminate some of the alleged fraud that has occurred and take the guesswork out of the asset verification process for federal contracting officers.

Reasonable Certainty About Claims

Another important public benefit of the proposed bill concerns the clear view it provides of the individual surety's asset. When the asset is easier to verify, project members who hold payment and performance bonds can reasonably expect that claims will be met.

This area is where last year's House subcommittee hearing on the bill provides important lessons. Past individual-surety frauds have used schemes involving re-insurance, mine securities and precious metals..

The extent of the possible deception can be seen in the June 2003 balance-sheet statement of Underwriters Reinsurance Co. The balance sheet listed assets of $1 billion, with half the value in "cash equivalents (Gold and Precious Metals)." To demonstrate the rock-solid legitimacy of the pledged assets, Underwriters Reinsurance used a "re-insurance debenture," chosen apparently for its formidable-sounding name, to confirm that the assets on the balance sheet will be available to benefit the project's owner and contractors. This is where contractors and contracting officers must be careful: Financial instruments such as debentures and trust receipts don't necessarily guarantee that the asset's value has been verified. Busy small contractors have little time to sort through it all.

Being able to see clearly the asset backing a bond will allow contractors and federal contracting officers to know the guarantees promised on paper are backed by honest companies pledging real assets.

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