Kristen Jordan sold off her dream company earlier this year because she couldn’t keep up with new state regulations designed to prevent the kind of fraud that cost employers millions of dollars in Maine two years ago.

What those regulations did instead was force Jordan and other small payroll processors out of business.

“This was my dream,” said Jordan of Mount Desert Island, who started MDI Payroll five years ago. “It was so cool to me to work here…to create my own company.”

Those rules required all payroll processors with direct access to their clients’ money be bonded, at a minimum of $50,000 and up to a maximum of $500,000 – bonds small processors could not buy because the bond companies wanted liquid assets as much as three times the amount of the bond.

“It was like you trying to buy the Empire State Building,” said David Gowen of Gowen Turgeon & Luetje of Windham, which does tax work and financial consulting, but also offers payroll services.

Gowen started working with his local legislators to change the law, and a bill is in for consideration this upcoming session, which starts next week.

“I’m much more optimistic than I was not too long ago. I’m optimistic for the industry in the state that we have a chance to basically stay in business,” Gowen said, or else only the big payroll companies will be left.

The impetus for the bonding requirements was a fraud case in 2003 where a Saco payroll company, Harmon-Baert, claimed to pay more than $2 million in payroll taxes to the IRS on behalf of its clients, but never did. Dozens of small businesses, who had set up escrow accounts with Harmon-Baert to handle their payrolls and associated taxes like withholding, social security and unemployment, were left owing the government money for taxes they thought already had been paid.

A similar case made headlines in 1996 when an Augusta-based payroll processor essentially did the same thing, costing employers $2.5 million.

Bill Lund of the state’s Office of Consumer Credit Regulation said Maine has a poor record of problems with payroll processors failing and that is what prompted the bonding requirement two years ago.

“The number of failures far exceeds any other state, much less any other state for our population,” Lund said. As a result, “the Legislature didn’t want to make a half-hearted effort” at better regulating the industry.

The minimum bond required is $50,000 and then escalates to cover the total amount of state and federal taxes owed by all the payroll company’s clients for their most expensive three-month period, up to a maximum of $500,000.

“That’s, in effect, how much they could misappropriate,” Lund said, since companies are required to make quarterly tax reports to the IRS and Maine Revenue Service.

The problem, Lund said, is the bonding companies didn’t come through.

“We were under the impression the bond market would respond to this need for a surety bond and make it readily available,” Lund said. That didn’t happen. And those that did were charging exorbitant prices.

The bonding houses wanted collateral in multiples of the face value, Lund said. “It was like having a $150,000 mortgage for a $50,000 bond…that was what was really difficult to believe.”

Lund tried to make the rules more flexible, allowing payroll companies to get letters of credit from their banks, and move up to the amount of coverage needed over a five-year period. The next step-up is required in January.

As a result of the bond rules, about 30 of the 100 payroll companies allowed to do business in the state are operating on conditional licenses right now, and they are the small, full-service processors. The rest are either big payroll companies or small processors that don’t handle escrow accounts.

“It’s fundamentally not fair,” said Gowen of Windham. “It requires, by law, something we can’t obtain,” he said, but is in easy reach of the biggest payroll companies, which have been buying out the small ones.

A bill co-sponsored by John Robinson, R-Raymond, and Sen. Bill Diamond, D-Cumberland, would essentially set up a pooled fund under the Finance Authority of Maine that would cover small payroll companies in the case of a failure. Participating payroll processors would pay a premium to belong to the pool and help build up the reserve.

“The fund would serve as a source of reimbursement if a fund went belly-up,” Lund said.

Rep. Robinson said a bipartisan group of legislators from the Windham area came together to find a solution so small payroll companies wouldn’t be pushed out of business.

“This is one of those situations where the Legislature created, with all good intention in mind, a bad business environment,” Robinson said of the bonding rule. “Now small processors will be able to purchase the bond through FAME,” if the legislation passes, he said.

The law change will come too late for Jordan, whose conditional license would only have been good through January.

“It’s too little, too late,” she said. “It takes six months for a good transition,” and she didn’t want to leave her clients in the lurch. She sold her payroll business to the much larger Paychex company and is now working on setting up a bookkeeping business.