Donald S. Clark
Re: 16 CFR Part 436
Dear Mr. Clark:
On February 26, 1997, the Federal Trade Commission ("FTC") issued an Advanced Notice of Proposed to amend its Trade Regulation Rule entitled Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures ("the Franchise Rule" or the "Rule"). The proposal is a continuation of the Commission's solicitation for comments which was initiated in April 1995.
The Office of Advocacy of the Small Business Administration was established by Congress under Pub. L. No. 94-305 to represent the interests of small business before federal agencies and Congress. In the past, Advocacy submitted comments on the FTC's proposal to amend the Franchise Rule and participated in the public hearings held by the FTC. The Office of Advocacy incorporates its previous comments by reference.
As in the past, the Office of Advocacy again commends the FTC's continued effort to amend the Franchise Rule and its commitment to gathering information to determine the most effective means for regulating an industry where true disclosure of information is crucial for assuring a level playing field for members of the small business community. The Office of Advocacy also commends the FTC for its continued compliance with the periodic review requirements of §610 of the Regulatory Flexibility Act. True disclosure of information may enhance the franchisor/franchisee relationship and minimize disputes which may be counterproductive for both the franchisor and the franchisee.
The FTC's Questions
In its Advanced Notice of Proposed Rulemaking, the FTC requests information about eight areas. Below please find Advocacy's comments on the individual areas.
The Franchise Rule
In the Advanced Notice of Proposed Rulemaking, the FTC states the comments elicited from the first notice generally expressed continuing support for the Franchising Rule. It stated that the pre-sale disclosure requirements of the Franchise Rule served as a cost-effective means for disseminating material information to prospective franchisees; prevented fraud; and reduced the level of post-sale franchise relationship disputes. It also stated that the Franchise Rule's benefits outweigh the costs imposed on consumers. Based on the comments received, the FTC has decided that the Franchise Rule serves a useful purpose.
The Office of Advocacy agrees with the comments received by the FTC and the FTC's determination that the Franchise Rule serves a useful purpose. As pointed out in our Comments of August 11, 1995, many states do not have statutes that address the issue of disclosure of information to potential franchisees.(1) Without the protection offered by the Franchise Rule, many small business entrepreneurs would be vulnerable to unsavory franchisors.
Uniform Franchise Offering Circular (UFOC) Guidelines
The FTC also requested additional comments on revision of the Franchise Rule to allow for the disclosure requirements of the UFOC guidelines.
In general, Advocacy supports any modification of the Franchise Rule that will provide for greater access to information for franchisees. Such information is necessary for franchisees to be able to make an informed choice about the decision to invest in the franchise.
The purchase of a franchise is a major financial investment for a franchisee. The decision to invest should be made after having an opportunity to investigate fully the financial soundness of the franchise, as well as the dynamics of the franchisor/franchisee relationship.
Advocacy acknowledges the fact that the additional disclosure requirements may be costly to the franchisor. However, considering the monetary outlay that is required by the franchisee to purchase a franchise, the additional cost for the franchisor in providing the disclosure information, should not be determinative. In fact, given the amount that the franchisor stands to gain, should the potential franchisee decide to invest, the cost of disclosing additional information may be minimal.
Disclosure of Litigation Information
The Office of Advocacy supports the modification of disclosure requirements to require franchisors to disclose law suits filed by franchisors against franchisees, in addition to suits filed by franchisees against franchisors. Litigation is a costly process for all parties involved. By providing information about law suits between a franchisor and its current franchisees, a potential franchisee may be able to obtain foresight into management style, behavior, and reasonableness of the franchisor before entering into a franchise agreement. For example, a law suit could provide information about the franchisor's performance, non performance, or interpretation of a franchise agreement, as well as its expectation of its franchisees. It can also give an indication as to whether a franchisor will utilize the courts for the purpose of harassing a franchisee.
Moreover, disclosure provides the potential franchisee with information about the franchisor's litigatory style. Is this a franchisor that is willing to negotiate when there is a point of contention? Does a particular franchisor institute a "paper them to death" policy that increases the costs of litigation so that participating in a suit, either as a plaintiff or a defendant, is prohibitive for a small franchisee? Because a small business's legal funds may be extremely limited, information about a franchisor's law suits could be crucial to the survival of the business.
Disclosure of Franchisee Statistics
The Office of Advocacy supports the disclosure of franchisee statistics similar to those found in Item 20 of the UFOC guidelines. Disclosure of statistics would provide information about the intrafranchise competition; the rate of growth of the franchise; and the relationship between the franchisor and its franchisees. By having information about the termination or cancellation of the franchise agreement; the likelihood of nonrenewal at the end of the franchise period; and the identity of previous franchisees the potential franchisee will be able to trouble-shoot for potential problems in the franchisor/franchisee relationship.
If a particular franchisor terminates the franchise relationship without just cause or has a tendency not to renew a franchise agreement, disclosure provides notice to the franchisee that his investment is not a permanent or quasi-permanent lifetime commitment. It is merely a temporary business investment where he may be one of several investors during the lifetime of the franchise. In other words, he is "renting or leasing" the opportunity, not "buying" a business for the purpose of true ownership.
Although the FTC seeks information about several aspects of business opportunities, Advocacy is particularly concerned about the amount of investment necessary to trigger Franchise Rule coverage. Advocacy contends that the $500 trigger amount should be lowered to $100 in order to curtail the number of unsavory companies that are beyond the reach of FTC because they sell their scandalous "business opportunities" for $495.
Advocacy is aware of one particular industry where the problem is pervasive. In the travel industry, there is currently a scam where a potential entrepreneur is given an opportunity to purchase the rights to become a travel agent. The entrepreneur is provided with papers that indicate that he is a travel agent although he lacks the proper training and credentials to perform in a competent manner.
The travel agency scam is problematic on several fronts. From the standpoint of the investor, the entrepreneur is being swindled out of his money. The negative experience could discourage the businessperson for pursuing business ventures in the future. Such discouragement has a negative effect on the economy by having entrepreneurs exit the marketplace.
For the public, an untrained travel agent does not have the skills to provide the necessary service to make the best travel arrangements. Moreover, some people who purchase the false credentials may not be using them as innocent entrepreneurs but as a means for defrauding the public.
Furthermore, the improperly credentialled agent can use the credential to obtain free and discounted travel services such as airfare, hotel/motel rooms, and meals. This is unfair to the businesses that provide the service, many of which may be small.
Lowering the amount to $100 reduces the revenue of the activity by 80%. Without a sizable profit, the appeal of the fraudulent activity is drastically reduced. While it may not discourage all such activities, it will act as deterrent. It also reduces the amount that an entrepreneur may lose by entering into a business arrangement with an unsavory character. These "boiler-room" type of scams may be localized. If so, a state official can use the rule to pursue state action. If interstate, then, it is probably beneficial to have Federal action.
The FTC has requested comments on whether the Franchise Rule should exempt trade show promoters from coverage as brokers. Advocacy adamantly opposes such an exemption. Trade shows are often the first contact that a potential franchisee may have with a franchise. Representations made at the trade show or in the advertisements for the trade show could be a determining factor in the decision to invest in a particular franchise. If the representations are false, the franchisee should have some form of recourse.
In the advanced notice of proposed rulemaking, the FTC expressed concerns about the fact that franchisors represent that the Franchise Rule prohibits them from making earnings disclosure. The Office of Advocacy is also concerned about such misrepresentations and supports the FTC' s attempt to clarify the rule. Advocacy approves of the suggested clarifying language found in interrogatory number 22. Moreover, in an effort to obtain full disclosure about a franchise's earnings, Advocacy opines that earnings disclosures should be required of all franchises, along with information about the percentage of outlets that do not achieve the earnings claimed.
In that Advocacy supports full disclosure of earnings information, Advocacy would have to oppose the language of interrogatory 24. Advocacy believes that a statement to the effect that "the franchisor does not make any representations as to earnings" could be seen as a disclaimer in instances where salespeople routinely make false or unauthorized earnings claims. In the event of a misrepresentation, a franchisee should have some form of recourse. Earnings disclosures are essential to assessing the value of a business opportunity. Such an "escape" clause should not be available to the profit-making franchisor.
New Marketing Approaches and New Technologies
The FTC questions whether it should modify its rule to clarify that it does not apply to international agreements. The Office of Advocacy believes that such clarification is necessary given the global nature of today's business environment.
Similarly, because of technological advances, Advocacy contends that the term "personal meeting" should be replaced with a term such as "first substantive transmission of information regardless of the mode of communication." As indicated in the proposal, technological advances have made the "personal meeting" standard obsolete. With the Internet, a franchisor can engage in a discourse and make a substantial number of representations to a potential franchisee long before an actual meeting occurs. Limiting the language to personal meeting would create a loophole in the Franchise Rule that could be harmful to the franchisee.
Self Regulation and Alternatives to Law Enforcement
The FTC is also requesting comments on whether it should develop a program to reduce or waive civil penalties for technical or minor violations of the Franchise Rule in response to the Administrations memorandum on Regulatory Reinvention Initiative. Advocacy supports the FTC's attempts to comply with the Regulatory Reinvention Initiative in an attempt to reduce regulatory burdens.
Many franchisors are also small businesses. The Office of Advocacy supports initiatives that will eliminate obsolete regulations and reduce the regulatory burden on the small franchisors, especially in terms of reducing/waiving civil penalties for minor or technical violations of the Franchise Rule. Advocacy's only concern is that the FTC balance the interests of the franchisors and the franchisees to assure that the regulatory reinvention does not unduly eliminate necessary protection for franchisees.
If you would like to discuss this matter or if this office can be of any further assistance, please contact Jennifer A. Smith. She may be reached either by mail at the above address or by telephone at (202) 205-6943.
1. See, page 9 of the Office of Advocacy's August 11, 1995 comment on franchising.