To: FTC <FRANPR@ftc.gov>
Date: 3/6/97 8:20am
Subject: 16 CFR Part 436
Based on my 17 years of legal and business experience exclusively in the franchise industry, that a significant amount of misrepresentation and abuse continues to exist in franchising.
There are currently NO standards a franchise company must meet in order to offer franchises. This is unlike the strict securities laws where companies must pass strict net worth requirements and the stock offering is subject to stringent standards.
Although the franchise laws weresupposedly modeled after the securities laws, the critical protective features of the securities laws were never carried over to franchise regulation.
You and I could decide today to start a franchise company for telecommunica-tions repair, for example. Let's say we have absolutely no experience or background in this area. And, let's say we decide to capitalize our new franchise corporation with only $1.
We'll have no problem at all in non-registration (FTC) states. Of course, we'll have to have an audit done of the opening balance sheet, reflecting cash of $1 and stock issued for $1. This simple audit is something a sole proprietor C.P.A. might charge $100 to perform. And we will have to include this audited statement is our UFOC (or FTC Disclosure Document).
The examiners at franchise registration states will at least consider the lack of adequate capitalization as a registration issue. However, I know of NO franchise company whose registration was ever declined on this basis. The examiners routinely give inadequately capitalized franchise companies their choice of: (a) putting all franchise fees into an escrow account until training is completed; or (b) inserting a provision in our franchise agreement saying the franchise fee is not payable until we have completed training the franchisee - no big deal.
How does this protect a prospective franchisee? And this is state-of-the-art franchise regulation in the late 1990's.
Now, let's say we want to sell some stock in our franchise company.
Forget about it - the securities laws are too strict. Now perhaps someone can explain why a franchise company can require someone to invest ALL of their net worth in a franchise "opportunity," yet this same company is unable to sell even $1 of its stock to this same individual?
Of course, someone will argue that prospective franchisees will seek out competent advisers to protect their interests. If this is true, why have studies consistently shown that only a minority of prospective franchisees use competent professionals before making a franchise investment decision. And, if using competent professionals is so important in franchise cases - and it most definitely is - then why is a prospective franchisee not REQUIRED to use a competent professional before making a franchise investment decision? The language on the FTC cover page "If possible, show this to someone who can advise you, like a lawyer or an accountant" implies a review-due dilligence process is only something to be done "if possible."
The reality is a significant number of prospective franchisees are lulled into believing the disclosure document has received a "stamp of approval" by some regulatory agency and therefore neglect any type of third party review. This is caused principally by misrepresentations made by franchise sales personnel. But the format of the FTC cover page also shares in the blame. Most prospective franchisees fail to carefully read inconspicuously placed language in the body of the FTC cover page. Many of my franchise clients, for example, remember the bold, capitalized statement about INFORMATION REQUIRED BY THE FEDERAL TRADE COMMISSION. They failed to read any further and falsely assumed the FTC was protecting their interests. At an absolute minimum, the sentence "We haven't checked it and don't know if it's correct" should be CAPITALIZED and placed in bold text. Just read this paragraph to see how the capitalized portions stand out.
Very truly yours,
Kevin Brendan Murphy
CC: Franchise Foundations <FranFnds@ix.netcom.com>