|April 28, 1997
Donald S. Clark, Secretary
Re: Franchise Rule 16 CFR Part 436
Dear Secretary Clark:
Attorney General Ryan has asked me to respond to your request for further comment on the Federal Trade Commission Franchise Rule. The responses and suggestions are the result of my discussions with our Franchise Bureau staff and with the Attorney General's Franchise Advisory Board, the members of which reflect franchisor and franchisee viewpoints. There is no doubt that the Franchise Rule serves a useful purpose.
SUBSTITUTION OF UFOC FORMAT
Substituting the UFOC (Uniform Franchise Offering Circular) format in place of the Franchise Rule disclosures is the right thing to do. The UFOC disclosure is more complete; easier to understand; allows easier comparisons; and now has a positive history of use. The changeover costs to small or regional franchisors not located in franchise regulatory states cannot outweigh the improved level of disclosure found in the UFOC.
There are some UFOC charges and clarifications that can be made now that we have experience with this format and FTC/NASAA (North American Securities Administrators Association) cooperation should continue to refine the Guidelines. It would also be helpful if the FTC would agree that future changes effected by NASAA must be complied with to satisfy the Franchise Rule, unless the FTC objects to such new standards. This would further the goal of uniformity that we should all be striving for.
Clarification of the item 20 "List of Outlets" might be an example of desirable UFOC finetuning to avoid duplicate or confusing franchisee listings. The list categories should be kept to a minimum, but with sufficiently comprehensive instructions to avoid losing franchisee names that are valuable resources to prospective franchisees. The history of open and closed sites plus present, former and "other" franchisees should present a complete "balance sheet" of what the status of people and sites is on a certain date. How to deal with subfranchisor's site statistics and details of any independent company operating sites under the same tradename might also be part of this discussion.
It would also be valuable for the FTC and the UFOC to make clear that franchisors violate their disclosure obligations if they prohibit their franchisees, or through settlement agreements with former franchisees, from answering prospective franchisees' questions. Providing a list of present and former franchisees is almost worthless if the franchisor can impose a veil of silence.
The litigation history of a franchise is an important source of information for prospective franchisees. One indicator of the "health" of a franchise system is the volume and nature of cases brought by the franchisor against its franchisees. Revealing such information should not be dependent upon the franchisee filing a counterclaim. A buyer should be far more interested in the pattern of litigation against franchisees than whether suppliers have sued the franchisor.
When adding this disclosure requirement for litigation and arbitration, multiple amendments to a franchisor's UFOC should be avoided. This could be done by establishing a rule that requires amending Item 3 no later than the franchisor's renewal date or at the time of making any other required UFOC amendment. The franchisor could also be required to provide a current litigation list upon request.
NASAA should be afforded more time to make any recommendations about changing the earnings claims requirements, including the possibility of mandatory earnings claims. However, certain clarifications could be made to the Franchise Rule now.
Without question the Rule should make clear that documented earnings claims are permitted [or even encouraged] by the FTC and that the franchisee's earnings history is an important discussion topic for prospects to have with present and former franchisees. Your Rule modifications suggested at the end of Part B. 5. b. might be changed with the following underlined language.
The FTC's Franchise Rule permits a franchisor to provide you with information about actual or potential sales, income or profits of its franchisees or company outlets, if there is a reasonable basis for such information and the franchisor offers to provide you with it does not make any representations about sales, income his franchiser or profits. We also do not allow our salespersons to make any such representations orally or in writing. You should notify an officer of this franchiser if any of our representatives make such performance representations of revenue" franchises should be viewed as "Stream having made an earnings claim when they represent that a certain level of investment will result in a minimum value of contracts provided through the efforts of the franchisor. Disclosure could also include what the remedy will be if the purported income is not realized during the contract period. Some companies may just extend the contract without additional payment instead of refunding a proportion of the fee.
AUDITED FINANCIAL STATEMENTS
A phase-in period of audited financial statements for start-up franchises that did not previously utilize audited statements could be up to three years. This guideline should clarify terms that conform to accounting standards and identify "audited", "compiled" or review statements so there is no mistake about what is expected and when.
"BUSINESS OPPORTUNITY" AND "FRANCHISE"
I continue to be of the opinion that the terms "business opportunity" and "franchise" should be distinguished from each other in the Franchise Rule, but I would suggest that comments on this subject on this subject be solicited from the Illinois Secretary of State, who is the administrator of the Illinois Business Opportunity Sales Law.
Tradeshow promoters should be treated as non-brokers unless they are compensated on a contingent fee basis that depends upon sales generated at or through a tradeshow. It would be helpful to either directly require or warn promoters that when their shows are conducted in registration states (franchise or business opportunity) that they must obtain evidence from each exhibitor that they are properly registered. Tradeshow promoters should also be required to notify regulatory states and the FTC as to where and when shows will take place.
It would be acceptable, in lieu of handing out copies of the UFOC at tradeshows to require franchiser exhibitors to provide an inspection copy in a prominent location at the booth, or provide an attorney's letter or regulatory letter stating the exhibitor is exempt.
"FIRST PERSONAL MEETING" AND INTERNET ISSUES
There is a need to at least expand the definition of "first personal meeting " to reflect the broader universe of sales contacts available to franchisors and their prospects or to find a more inclusive phrase. Your suggestion of "first substantive discussion" is a good one and might be defined as follows:
The first time a franchisor representative explains the advantages or reasons why the prospective buyer should invest in one or more of its franchises as opposed to other franchises or other means of earning income. Disclosure is required when this first time contact is in person, by electronic means or in writing if substantive details about the franchise are discussed.
There should be some recognition of the fact that the level of sales pressure is less on the intemet or telephone and therefore meeting initial disclosure obligations by use of the internet would appear to be reasonable as a first step. However, regardless of how internet disclosure is resolved, the franchisor should also be required by the Franchise Rule to provide a hard copy of the disclosure documents to prospects at least ten or more business days before any payments are made or any agreements are signed.
An alternative to the "first substantive discussion" would be to increase the gap period to 30 calendar days and not be involved in defining what a "material" or "substantive" discussion is or when it occurred. UFOC disclosure in a hard copy would have to precede payments and the signing of contracts by at least 30 calendar days. This would avoid numerous issues about how and when a prospect was contacted.
"Co-branding" could take three forms. The first would be where a parent company has two or more brands under its umbrella and sells them at the same time for a particular site. The second could be an existing franchisor and franchisee system that agrees to bring in another independent franchise system to market both systems' products at a particular site. The third category could be two or more co-branded franchise systems that will jointly sell a co-brand franchise site with the franchisee simultaneously contracting for both brands.
Disclosure should advise the prospective franchisee as to what rights and responsibilities will follow in the event one brand terminates the franchisee or one franchisor goes out of business. Until there is more experience with co-branding there should be separate disclosure for each system together with the two franchisors' contract and the three-way contract among the franchisors and the franchisee.
Some franchisors allege that a regulator is not interpreting the UFOC Guidelines like other states and therefore is unfairly imposing extra expenditures of time and money to comply.
Some franchisors allege that a regulator is not interpreting the UFOC Guidelines like other states and therefore is unfairly imposing extra expenditures of time and money to comply. Sometimes a check with other states reveals no conflict or alerts the other states to something they overlooked, but which is not a conflict of interpretation. In other instances a genuine conflict may occur over what the UFOC requires.
Consider establishing a joint committee made up of NASAA and FTC representatives [with or without outside advisory members] that would respond to conflicting interpretations among regulatory states and the FTC regarding UFOC requirements. This resolution process would be initiated by any regulatory state, the FTC or a franchiser that can demonstrate conflicting regulatory UFOC interpretations which materially affect UFOC uniformity. The joint committee would advise all regulators of the issues, seek their input and arrive at a conclusion. The review process could be done in person, by letter, fax and phone to reach a prompt result depending upon the complexity of the issue.
Before this process could be initiated, two or more regulatory agencies would have to have interpreted a UFOC provision differently and after discussion among the respective regulators and franchisor(s), been unable to agree upon a single interpretation. Regulatory agencies relying upon their own legislation or rules that are independent of the UFOC guidelines would not be the subject of this review process, even if the result is additional disclosure documents or data. However, the joint committee could issue an advisory opinion that asks for the conflicting statute or rule to be amended.
Although regulatory agencies would be expected to abide by the recommendations of the joint committee, including regulators that may not have been directly involved in a particular issue, adhering to the decision would not be mandatory. I would make every effort to follow such a joint committee's decision or advisory opinion in the interest of uniformity.
Robert A. Tingler