December 21, 1999 Mr. Donald S. Clark Re: 16 CFR Part 436 -- Franchise Rule Comment Dear Mr. Clark: The International Franchise Association ("IFA") is pleased to submit this comment in response to the Federal Trade Commission's ("FTC") Notice of Proposed Rulemaking ("NPR") to amend its trade regulation rule entitled "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures" ("Franchise Rule"). IFA is a trade association that has been the voice of the franchise community in the United States since 1960. IFA represents 800 franchisors, 1,000 individual member franchisees and 28,000 franchisees affiliated with the 45 franchise association members of the IFA. IFA also represents more than 300 product and service suppliers to the franchise community. These members have, among other programs, worked together with public officials, domestically and internationally, to shape the laws and policies that govern franchising, with the goal of promoting franchise growth and protecting the interests of both franchisees and franchisors. As IFA's nearly 40-year record of accomplishments amply demonstrates, IFA has consistently supported regulatory policies designed to ensure that prospective franchisees receive relevant information about their proposed franchise purchase sufficiently in advance of their purchase to permit them to make an informed and unpressured purchase decision. IFA also has supported a proper balance between the legitimate disclosure needs of prospective franchisees and the compliance burdens and costs -- borne by both franchisors and franchisees -- that such disclosure inevitably requires. IFA actively participated in the deliberations leading to the promulgation of the Franchise Rule in 1978, as well as in the recent proceedings that have led to the proposals contained in the NPR. We want to express our deep appreciation to the FTC staff for the manner in which it has conducted this review process, beginning in early 1995 with the informal request for comment, to the first three-day public workshop in September 1995, through the subsequent workshop in 1996, the Advanced Notice of Proposed Rulemaking in early 1997 and the subsequent regional workshops held around the country in 1997. Throughout this process the FTC staff demonstrated a commitment to fully discussing and attempting to address the concerns of all interested parties, and we believe that this commitment is clearly reflected in many of the proposed revisions to the Rule. The FTC staff has obviously listened thoughtfully to prior comments and has proposed a number of excellent revisions to the Rule. We have encouraged our franchisor and franchisee members, many of whom have previously responded to the FTC’s invitation to comment on the Rule, to once again submit individual comments to the FTC. It is our hope and expectation that these individual comments will reflect our members' actual and diverse experiences in selling and purchasing franchises in compliance with the Franchise Rule's pre-sale disclosure requirements. Our goal, one we recognize is shared with the FTC, is to provide the FTC with the most comprehensive information possible about the experiences of franchisors and franchisees with the disclosure process. The most comprehensive analysis of the information contained in disclosure documents is the recently published "Profiles of Franchising" ("Profiles"), a statistical analysis of the information contained in 1,170 disclosure documents filed in franchise registration states. This information was compiled and analyzed by FRANDATA on behalf of the IFA Educational Foundation, and we attach it for your general information. The IFA comment is the product of many discussions between and among each of the constituencies of the IFA’s membership – franchisors, franchisees and suppliers – and appropriately reflects the goal of the IFA to achieve a disclosure format that is in the best interests of the franchise community. This comment was reviewed and discussed by the IFA Executive Committee, Board of Directors, Franchisee Advisory Council and Corporate Counsel Committee, among others. The issues highlighted in the comment are not the only issues of interest to IFA’s members, but rather are those that IFA’s members believed to be of greatest significance to the franchise community. IFA may provide additional comments, either during the rebuttal period or during any public workshop or conference, on issues not addressed in this comment. First, IFA strongly supports the FTC’s recommendation to remove business opportunities from coverage of the franchise rule. We believe that the structure, operations and experiences of business format franchises are sufficiently different from business opportunities to warrant creation of a separate rule for each. We applaud the recommendation that the Rule distinguish between business format franchises and business opportunities. Second, we strongly support the FTC’s decision to replace the format of the Rule with the format adopted by, and in use in, the franchise registration states. The Uniform Franchise Offering Circular ("UFOC") is the disclosure format of choice for the great majority of franchise systems, and it seems sensible to attempt to achieve greater uniformity of franchise disclosures by replacing the FTC format with the UFOC format. In addition, the UFOC format was recently revised and contains a number of provisions that provide significantly greater information to prospective franchisees than does the current version of the FTC disclosure format. This includes in particular Item 20, which provides information to prospective investors about franchised outlets within the system, including the names, addresses and telephone numbers of current and former franchisees. Third, we applaud the FTC for recommending that the rule be clarified to reflect its application to exclusively domestic – as opposed to international – franchise sales. We agree that there is no evidence of benefit to prospective foreign investors from attempting to apply the Rule extraterritorially, and we believe that in fact such attempts may result in confusion about or conflict with regulatory and statutory obligations in foreign jurisdictions. Fourth, we strongly support a revision to the Rule permitting electronic disclosure. The FTC staff clearly recognizes the benefits recent technological advances offer in providing a mechanism for swift, cost-effective disclosure. We do have some concern that continuing to require a franchisor to furnish hard copies of the cover page, table of contents and receipt may undermine the effectiveness of this provision. While the concept is sound, we believe that further widespread use of electronic communication may make such hard-copy disclosures unnecessary in the near future. In order to maintain the utmost flexibility, we encourage the FTC to consider some mechanism (short of an additional rulemaking) that would permit the FTC to eliminate any paper requirements in the disclosure process as electronic disclosure technology advances permit. This will ensure that the beneficial effects of electronic disclosure are not compromised by the requirement of additional paper disclosures. We would like to add that we believe the issue of electronic transfer of disclosure documents, increasing use of the internet and other issues related to the technological changes affecting the marketplace might be an appropriate subject for additional discussion between the FTC and interested parties. We believe that the franchise community would benefit from the FTC’s additional clarification about the impact of the technology age on the franchise sales and disclosure process, and the IFA would be interested in participating in any further discussion of this issue that the FTC might propose. Fifth, we strongly support the proposed exemptions for sophisticated investors, and agree with the FTC’s rationale that "the Rule’s protections may be unnecessary where the likelihood of abuse does not exist." IFA believes that the exemption is justified wherever there is strong likelihood that the investor is able to make an informed purchase decision without receiving a franchise offering circular. However, IFA suggests that the minimum threshold for the exemption be modified. We believe that a level of sophistication sufficient to justify an exemption from the disclosure protection of the Rule exists in transactions involving amounts lower than the proposed $1.5 million threshold. We suggest that the FTC instead consider a threshold of $1,000,000 as the trigger for exemption, a figure that we believe better reflects the sophistication of those investing in franchised businesses in today’s economy. We also believe that by reducing the exemption threshold, the FTC will simultaneously achieve two important objectives: first, reduce regulatory burdens on franchise companies whose franchise investors, because of their sophistication, do not benefit from the protection offered by the Rule; and second, preserve and properly direct the enforcement resources of the FTC to the kinds of franchise sales transactions that, because of the amount of the transaction, involve less sophisticated investors most likely to benefit from the protection provided by the Rule. As mentioned in the introduction to this comment, the IFA Educational Foundation published the second in a series of "Profiles of Franchising" ("Profile") which reviewed the information contained in 1,170 Uniform Franchise Offering Circulars filed in registration states in 1997 (see Appendix A). The Profile identified 52 franchise companies offering franchises with initial investments exceeding $1 million. Unfortunately, the study did not capture information on how many of these 52 companies may have involved investments exceeding $1.5 million (See Appendix B). We believe that franchise sales transactions involving minimum investment amounts of $1,000,000 or more (excluding real estate) – and occurring in 4.4% or fewer of all franchise systems – should be exempt from the disclosure requirements of the Rule. We strongly agree with the FTC’s recommendation to exempt from application of the Rule transactions in which the sophistication of the investor makes the protections of the Rule superfluous. We believe, however, that those transactions occur at investment levels beginning at $1,000,000, rather than $1.5 million. Significantly, we also believe that a broadened exemption will help the FTC focus its limited enforcement resources and enhance the FTC’s ability to execute its primary mission with regard to the Franchise Rule: namely, to monitor transactions and initiate enforcement actions in franchise sales involving unsophisticated investors. Sixth, IFA strongly supports the recommendation that the FTC eliminate the "first personal meeting" standard for triggering a disclosure obligation, and replace it with a bright-line standard of 14 days. This reflects the FTC’s understanding of the significant confusion, particularly in the electronic age, of determining what level of contact constitutes the "first personal meeting." This standard continues to ensure that prospective investors will receive information regarding their franchise investment well in advance of any obligation to make an investment decision. Seventh, we would urge the FTC to eliminate the provision requiring that the final contract be delivered to franchisees 5 days before the contract is signed. This provision, while well-intentioned, actually penalizes franchisees and discourages last minute negotiations or revisions to the franchise agreement. Franchisees frequently have financial or other considerations that make additional delays in closing a franchise deal costly or prohibitive; as a result, any late change to the franchise agreement results in an additional 5 day delay which will normally create more hardship on the franchisee than the franchisor. We suggest that the FTC eliminate this provision in order to promote continuous dialogue between franchisors and franchisees regarding the terms and conditions of the franchise agreement. Eighth, the IFA strongly supports the recommendation that the Rule not contain a mandatory earnings disclosure. The IFA’s members believe that a mandatory, one-size-fits-all approach to financial performance is impractical, as it fails to take into consideration the many variations that exist among the dozens of industries and thousands of companies that employ franchising as a method of expanding their businesses. The IFA agrees with the FTC that such information is currently readily available, either directly from franchise companies that make earnings claims (various studies indicate that approximately 20%-25% of franchise companies currently make such information available to prospective franchisees during the disclosure process) or through direct communication with current and former franchisees (information provided in Item 20 of the UFOC). IFA’s members believe that the competitive force of the marketplace should drive the decision-making process regarding whether or when individual franchise systems make earnings disclosures. We are very encouraged that the FTC has adopted a similar philosophy in its decision not to mandate uniform disclosure of earnings information. We are equally enthusiastic about several of the FTC’s recommendations for revisions to Item 19. In particular, we believe that the proposed adoption of a two-part preamble to Item 19 will clarify for prospective investors that: (1) franchise systems are permitted to make financial performance information available under the Rule, and that (2) unless such information is substantiated in writing, prospective investors should not rely on such information. We believe that this approach – affirmatively informing would-be investors about the requirements under the Rule and the manner in which such information should be disclosed – when combined with the competitive force of the marketplace, ensures that earnings information can be identified and properly appraised by franchise investors. Ninth, we would encourage the FTC to extend from 90 to 120 days after fiscal year end the date by which a franchisor must annually update its disclosure document. As a practical matter, many franchise systems (particularly those with a December 31 fiscal year end) have difficulty obtaining an audited financial statement within 90 days of their fiscal year end. An extension to 120 days will reduce the burden on franchise companies to obtain audited financial statements, is consistent with similar approaches in a number of the registration states and will not materially diminish the disclosure received by a prospective franchisee. Tenth, we are concerned about the proposal that franchise systems be required to make various disclosures relating to their parent corporation. We believe that these disclosures, particularly of litigation involving the parent corporation or the financial statements of the parent corporation, will be of little value to prospective franchise investors. Publicly traded parent companies may be involved in significant litigation wholly unrelated to the operation or financial health of the franchised subsidiary. Moreover, required disclosure of financial statements may mislead franchise investors and cause unrealistic reliance on the parent’s financial statement rather than on that of the franchise company. We believe that these additional disclosures, while well intentioned, may be confusing and misleading and provide little benefit to franchise investors. We hope that the foregoing comments are helpful, and again express our appreciation for the thorough and thoughtful analysis reflected in the NPR. We believe that, viewed in its entirety, the proposed Franchise Rule amendment reflects a positive step forward. Depending upon the IFA's review of other comments filed with the FTC in response to this NPR, IFA may wish to file a rebuttal comment. IFA would also like to participate actively in any informal public workshop, hearing or conference that the FTC may choose to conduct to discuss the issues raised in its NPR and the comments submitted in response to the NPR. Sincerely, Matthew R. Shay |