Bundy & Morrill, Inc., P.S.
February 14, 2000
Donald S. Clark, Secretary
Dear Secretary Clark
Please accept this letter as my Rebuttal Comments regarding the proposed Franchise Rule. You will note that I previously commented by letter dated December 22, 1999. I have not changed my views on any of the opinions previously expressed.
It is necessary to preface this letter with the observation that, with less than thirty days to attempt to review over 40 lengthy comments (some of which are not yet electronically available), it is not possible to even read, much less respond to, every one of the comments in the record. Because of the large number of very important issues involved in this NPR, I would respectfully request that the Commission extend the rebuttal period by sixty days to permit a more thoughtful review by all interested parties.
As to the new issues presented by the Commission's proposals relating to the internet and other forms of electronic communication of franchise disclosure documents, I would request that the Commission consider an additional round of regional open-forum workshops in order to attempt to address some more of the issues. There seems to be widespread, but generalized, support for the Commission's overall approach, but equally widespread apprehension that if the Commission acts hastily it could discourage rather than encourage electronic distribution of franchise disclosure documents--or create a need for another rule-making proceeding to fix a problem created this time. With the discussion now focused upon the Commission's proposal, I believe that such a limited round of workshops would result in concrete proposals that would improve the quality of disclosures while encouraging the use of such media. The technology is simply too new and the industry does not have the experience it needs to make decisions in the fast-paced rule review proceeding. All of the other, more conventional, issues have preempted the attention of the commenters and left this important issue without the attention it deserves and needs. I urge the Commission to use the Workshop mechanism to focus the attention of all interested parties on addressing this future-oriented issue.
In this rebuttal letter, I will focus on just a few issues rather than attempting to address every comment made in the opening round. By limiting myself, I do not mean to imply that I acquiesce in any of the comments submitted (or necessarily, that I disagree). It simply is not possible to provide thoughtful responses to so many comments on so many topics.
First, a general comment: As the Commission continues with its decision-making process, I urge you to keep in mind the salutary purpose of the rule--to provide full and complete disclosure of all material information to prospective franchisees before they make an investment decision. Many of the franchisor industry comments, in effect, asked the Commission to take a step backward into the 1970s and reduce the type and quality of disclosure required. Others proposed, in various ways, that the Commission merely maintain the status quo. I urge the Commission to reject those invitations and maintain its focus upon prospective franchisees and upon maximizing the amount of information they have access to and increasing the fairness of the decision process. The goal should remain to decrease the opportunities for unscrupulous franchisors to work a fraud on prospective franchisees--by either deceiving them about what they are buying into or by depriving them of access to accurate information. If the Commission keeps this goal in mind, the result of the process will be an improved franchise rule.
As I indicated above, I do not believe that the issues around electronic distribution of franchise disclosure documents have been adequately discussed or addressed by either the Commission or the commenters. Besides myself, I have identified only two commenters who gave some thoughtful treatment to the subject, and I commend them for it--the NFC and FranData. Although the three of us approached the issue from slightly different directions, we came out not expressly disagreeing on any major points. I represent both franchisees and franchisors and am a strong advocate of electronic communication of franchise disclosure documents. I hope the Commission will focus upon trying to facilitate responsible electronic communications--without imposing technical requirements that neither improve the certainty that the prospective franchisee actually receives the document or that he or she will actually read it. It would be better to take a few more months developing this issue than to adopt a rule that effectively makes electronic communication impossible pending another rule review.
At the same time, it is important that the Commission figure out how to deal with issues such as how to prevent franchisors from requiring prospective franchisees to drill through page after page of graphic-rich advertising materials before they can reach the "legal stuff". As the proposed rule currently reads, it would permit franchisors to make such a posting of the franchise disclosure document somewhere in a remote corner of their advertising web-site--so long as it was a "discreet document" once the prospect found it. The same would be possible on a compact disk or a digital video disk. It takes no leap of logic to understand that a prospective investor, having traveled through several minutes of a colorful, entertaining sales presentation, will find a simple black on white franchise disclosure document incredibly boring by comparison and he or she will be less likely to give it the importance it deserves. A careful franchisor could easily design a web-site or other medium that would cause the prospective franchisee to give as little heed to the franchise disclosure document as most consumers now give to the license agreement they must "view" and "agree to" before they can download a software update from Microsoft. Adopting a rule that would permit or encourage such fraudulent devices would not further the Commission's objectives.
Based upon the widespread objections to the Commission's proposed mandatory disclosure of the existence of gag clauses, it must be an excellent idea. Although there might be no harm in finding another term if the industry thinks "gag clause" is too pejorative, and there might be some merit in considering a more narrow definition of a "gag clause" to exclude "generic" trade secrets provisions and perhaps certain other categories of agreement, this is an important bit of information for prospective franchisees to have. If they know that such clauses exist, they understand that those former franchisees from whom they most need to obtain information may not be able to talk with them about what they need to hear.
Unlike the common thread running through many of the comments, I do not believe that such a disclosure would discourage franchisors and franchisees from settling disputes. Settlements are generally based upon purely economic terms--both sides are trying to minimize their down-side economic risks. No rational franchisor is going to risk going to trial before a jury where they could sustain a million dollar judgment instead of entering into a settlement--even if they do have to disclose that, as a condition of settlement, they required the franchisee to not talk about his/her relationship with the franchisor. In any event, Franchisors tend to adhere to the cynical belief that franchisees never read or understand the disclosure document anyway. The parties to disputes will continue to act rationally--just as they have in the face of mandatory litigation disclosures.
In the interest of providing prospective investors with as much material information as reasonably possible at a minimal cost to franchisors, the Commission should retain its proposed mandatory disclosure of "gag clauses", subject to some minor editing to address valid concerns about definitions and "loaded" words. Perhaps, instead of "gag clause", the Commission could adopt the term "contracts to not speak the truth".
First Personal Meeting Requirement
Most of the industry comments were quick to embrace the Commission's proposed elimination of the requirement that the franchise disclosure document be delivered at the first personal meeting. Although I concur that the concept of a first personal meeting has become largely irrelevant in a modern world, I urge the Commission to look again at the underlying purpose for the requirement in the first instance. The clear purpose was to make sure that early in the process, the prospective franchisee understood that the franchise disclosure document was important and that they should consider its contents in making their decision. Few franchises are sold in a month. Under the Commission's proposal, it would be possible for the franchisor to require the prospect to travel one or more times to the headquarters office, and to have multiple meetings in the field, all involving "wining and dining" and requiring expenditure of resources in supposed "due diligence". Franchisors know that if they can secure such tangible commitment from a prospect, it is easy to "reel them in". If they have courted for several months, it is relatively easy to de-emphasize the importance of what appears on the surface to be a redundant (and boringly presented) franchise disclosure document. The Commission should devise a mechanism, such as the paper (or other medium) summary disclosure document, which must be delivered during or with the first substantive contact (including with any electronic or paper sales brochure).
I would suggest imposing a "first substantive contact" requirement for providing a copy of a summary disclosure document. The "first substantive contact" would be any contact from the franchisor, including in response to a telephone or other electronic communication in which the franchisor provides the prospect with any information designed to encourage the prospect to invest in a franchise or which advances the process toward making a formal offer of a franchise (including sending an "application form"). There is no reason that the summary disclosure document could not be sent by an electronic communications medium so long as it included a receipt mechanism that required some affirmative acknowledgement by the prospective franchisee. I propose a three calendar day requirement for sending the summary disclosure document in order to address the situation where someone otherwise properly responds to a telephone or other electronic communication inquiry. The franchisor should have the burden of proving that he sent the summary disclosure document. Regarding the content of the summary disclosure document, it is mostly important that it alert the prospective franchisee to his/her right to receive a franchise disclosure document, and of the importance of that document in the decision process. It may be possible to use the same form of summary disclosure document as required for electronic communication of the franchise disclosure document. One legitimate goal would be to minimize the inconvenience to franchisors in having to distribute and track redundant pieces of paper or electronic communications.
Financial Performance Information
My views on this topic should be well known to the Commission. I strongly advocate mandatory disclosure of financial performance information where the information is or reasonably should be available. Alternatively, I would make disclosure mandatory but permit franchisors to opt out IF they boldly disclose that the absence of such information makes investing in their franchise an extremely risky and dangerous decision. It is just not possible to argue that financial performance information is not material to a prospective franchisee. In fact, it is essential. The truth is, that virtually every franchisor gives it. They simply give it illegally. I urge the Commission to force the industry out of the closet on this issue and require full and complete disclosure--as currently required by many of the state disclosure statutes and by the common law fraud duty-to-speak doctrine.
Beware of those who would urge "top-line only" disclosure or "expenses only" disclosure. Having given that much information, every franchisor is obligated, under common law fraud doctrines, to provide complete and full disclosure--so as not to omit any fact necessary in order to make the information given not misleading. I urge the commission to reverse its tentative decision on this issue and align itself directly with full disclosure of these most critical facts.
On one point, I agree with some of the industry commenters. The Commission's proposed requirement that financial performance information comply with "generally accepted accounting principals" would have an adverse effect upon the effort to obtain full disclosure. If the Commission determines to not mandate such important disclosures, it, at least, should not actively discourage voluntary disclosures. Very few franchisors require (or can afford to require) their franchisees to have annual audits. In many many cases, the audit fees would exceed the net profits of the franchisees. However, in virtually all cases, franchisors collect or have a contractual right to collect, earnings information from all franchisees. Because that information is the basis for both (a) paying royalties and (b) paying taxes, it has reasonable indicia of reliability. With appropriate disclaimers that it is un-audited information, it can provide a very valuable source of information for a prospective franchisee. The Commission should eliminate the "GAAP" requirement.
I thank the Commission for providing this open process for comments upon the proposed rule. In reviewing the comments on the record, the Commission should keep in mind that those who are most affected are often the least likely to comment. They are the current and former franchisees. The former franchisees (those who got out in one way or another) usually have gotten on with their lives and have no continuing contact with the franchise industry. They do not know about this NPR and, if they did, would not take time to comment because they would never even consider making another mistake. Equally, many current franchisees fear that, if their franchisor perceives them as speaking against the franchisor's interests, they will somehow be punished or deprived of anticipated benefits. I just spoke at a convention of about fifty franchisees who openly expressed such concerns. I urge the Commission to remain carefully focused on the purpose of maximizing the amount of reliable information available to prospective franchisees before they invest. That is the time when regulation can very clearly help the consumers--those who would view investing in a franchise as the best way to get into a business. They need to understand the whole truth about the business they are considering investing in and the whole truth about the franchise industry.
Thank you for your consideration.
Howard E. Bundy