FTC's Beales Testifies on the Commission's Enforcement of the Franchise Rule

"Based upon the Commission's two decades of experience in enforcing the Franchise Rule, it is clear to us that deceptive business opportunity sales, rather than business-format franchise sales, remains a persistent cause of significant injury to American consumers," a Federal Trade Commission official told a Congressional panel today. J. Howard Beales, III, Director of the FTC's Bureau of Consumer Protection, noted that since the enactment of the Franchise Rule in the late 1970s, the FTC has vigorously enforced its provisions. The FTC has brought over 200 franchise and business opportunity cases against more than 640 entities and individuals, Beales said. Recently, the Commission announced its seventh joint law enforcement sweep against business opportunity and related schemes, and together with the Department of Justice and other state partners filed over 70 cases, Beales noted.

Beales delivered the FTC testimony today on the Commission's enforcement of the Franchise Rule before the House Subcommittee on Commerce, Trade and Consumer Protection of the Committee on Energy and Commerce.

The Franchise Rule covers the sale of franchises and business opportunity ventures. Franchises typically involve retail outlets that bear the franchisor's trademark and follow the franchisor's business operations model, such as fast-food restaurants or hotels. Business opportunities often do not entail a trademark or a detailed business plan. Instead, business opportunity promoters typically promise to provide the buyer with equipment that is used to sell products or services to the public, such as vending machines, rack displays, pay phones, or medical billing software. Business opportunity promoters also frequently promise to find the buyer a market for the products or services sold by securing locations or accounts for the equipment used in the business, such as placing vending machines or display racks in airports or bowling alleys, or by providing the names of doctors seeking medical billing assistance.

According to the testimony, the FTC receives a considerable amount of consumer complaints involving the sale of business opportunities. Between 1993 and mid-1999, Beales said, FTC staff analyzed 4,512 franchise and business opportunity complaints in the Commission's Consumer Information System (CIS) database. Of these complaints, 3,392 - more than 75 percent - involve business opportunities. The FTC received an additional 832 complaints about companies that did not appear on known lists of franchisors and most likely were business opportunities. Only six percent of the complaints pertained to traditional franchise arrangements. Complaints were lodged against 949 business opportunity sellers, but against only 197 franchisors.

"Our law enforcement experience shows that business-format franchising has matured," Beales said. "Many franchise systems today are established, well-respected, household names." He noted that while fraud may occur in the sale of some franchises, the Franchise Rule's pre-sale disclosure requirements provide valuable information to help protect against fraud. Violations occur most often among small, start-up franchisors who may not be well-versed in the Franchise Rule's disclosure requirements. As a result, the FTC has received few franchise complaints alleging fraud, deception or substantive Rule violations by business-format franchisors, Beales said.

The testimony noted, however, that the same is not true for business opportunity sellers. "Compliance with the Franchise Rule by business opportunity sellers is low. Many business opportunities are outright scams that disappear shortly after taking consumers' money," Beales added. He highlighted the results of a 2001 staff review of the FTC's Franchise Program. According to that report, between 1993 and 2001, the FTC brought 170 franchise or business opportunity cases against 330 entities and 305 individuals. Of the 170 cases, 148 were against business opportunity schemes. The FTC's actions involved the deceptive sale of vending machine and display rack opportunities, pay telephones, fax and Internet access ventures, 900- number telephone scams, and medical billing opportunities. The report further noted that almost all of the cases involved false or unsubstantiated earnings claims and most alleged that the promoter failed to provide prospective purchasers with any disclosures at all.

In addition to violating the Franchise Rule, the report noted, business opportunity sellers frequently violate Section 5 of the FTC Act by luring unsuspecting consumers to invest. For example, they often make false earnings projections and false promises of exclusive market territories and use shill references or false testimonials to create the impression that their business is safe and profitable. They also typically misrepresent the availability or profitability of locations for vending machines or other equipment; their prior success; the assistance to be provided to the purchaser; and the nature of their products or services.

"Injury to individual consumers resulting from business opportunity fraud is also among the highest levels of injury we see in consumer protection," Beales said. He noted that between 1993 and June 1999, FTC staff's analysis of the complaint data shows that more than 650 consumers each reported losses of at least $10,001, with an additional 631 consumers reporting losses between $5,001 and $10,000, and 621 between $1,001 and $5,000. Business opportunity fraud often results in consumer losses of over $1 million each month. For these reasons, the FTC continues to focus much of its Franchise Rule enforcement and consumer educational resources on combating business opportunity fraud, Beales said.

In conclusion, Beales stated, "The Commission will continue to dedicate significant law enforcement resources to targeting business opportunity fraud."

The Commission vote to approve the testimony was 5-0.

Copies of the testimony are available from the FTC's Web site at http://www.ftc.gov and also from the FTC's Consumer Response Center, Room 130, 600 Pennsylvania Avenue, N.W., Washington, D.C. 20580. The FTC works for the consumer to prevent fraudulent, deceptive and unfair business practices in the marketplace and to provide information to help consumers spot, stop and avoid them. To file a complaint, or to get free information on any of 150 consumer topics, call toll-free, 1-877-FTC-HELP (1-877-382-4357), or use the complaint form at http://www.ftc.gov. The FTC enters Internet, telemarketing, identity theft and other fraud-related complaints into Consumer Sentinel, a secure, online database available to hundreds of civil and criminal law enforcement agencies in the U.S. and abroad.

(Matter No. R511003)