[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
THE FTC'S FRANCHISE RULE: TWENTY-THREE YEARS AFTER THE PROMULGATION
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HEARING
before the
SUBCOMMITTEE ON
COMMERCE, TRADE, AND CONSUMER PROTECTION
of the
COMMITTEE ON ENERGY AND COMMERCE
HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
__________
JUNE 25, 2002
__________
Serial No. 107-116
__________
Printed for the use of the Committee on Energy and Commerce
Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
U. S. GOVERNMENT PRINTING OFFICE
80-679 WASHINGTON : 2002
___________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512-1800
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001
__________
COMMITTEE ON ENERGY AND COMMERCE
W.J. ``BILLY'' TAUZIN, Louisiana, Chairman
MICHAEL BILIRAKIS, Florida JOHN D. DINGELL, Michigan
JOE BARTON, Texas HENRY A. WAXMAN, California
FRED UPTON, Michigan EDWARD J. MARKEY, Massachusetts
CLIFF STEARNS, Florida RALPH M. HALL, Texas
PAUL E. GILLMOR, Ohio RICK BOUCHER, Virginia
JAMES C. GREENWOOD, Pennsylvania EDOLPHUS TOWNS, New York
CHRISTOPHER COX, California FRANK PALLONE, Jr., New Jersey
NATHAN DEAL, Georgia SHERROD BROWN, Ohio
RICHARD BURR, North Carolina BART GORDON, Tennessee
ED WHITFIELD, Kentucky PETER DEUTSCH, Florida
GREG GANSKE, Iowa BOBBY L. RUSH, Illinois
CHARLIE NORWOOD, Georgia ANNA G. ESHOO, California
BARBARA CUBIN, Wyoming BART STUPAK, Michigan
JOHN SHIMKUS, Illinois ELIOT L. ENGEL, New York
HEATHER WILSON, New Mexico TOM SAWYER, Ohio
JOHN B. SHADEGG, Arizona ALBERT R. WYNN, Maryland
CHARLES ``CHIP'' PICKERING, GENE GREEN, Texas
Mississippi KAREN McCARTHY, Missouri
VITO FOSSELLA, New York TED STRICKLAND, Ohio
ROY BLUNT, Missouri DIANA DeGETTE, Colorado
TOM DAVIS, Virginia THOMAS M. BARRETT, Wisconsin
ED BRYANT, Tennessee BILL LUTHER, Minnesota
ROBERT L. EHRLICH, Jr., Maryland LOIS CAPPS, California
STEVE BUYER, Indiana MICHAEL F. DOYLE, Pennsylvania
GEORGE RADANOVICH, California CHRISTOPHER JOHN, Louisiana
CHARLES F. BASS, New Hampshire JANE HARMAN, California
JOSEPH R. PITTS, Pennsylvania
MARY BONO, California
GREG WALDEN, Oregon
LEE TERRY, Nebraska
ERNIE FLETCHER, Kentucky
David V. Marventano, Staff Director
James D. Barnette, General Counsel
Reid P.F. Stuntz, Minority Staff Director and Chief Counsel
______
Subcommittee on Commerce, Trade, and Consumer Protection
CLIFF STEARNS, Florida, Chairman
FRED UPTON, Michigan EDOLPHUS TOWNS, New York
NATHAN DEAL, Georgia DIANA DeGETTE, Colorado
Vice Chairman LOIS CAPPS, California
ED WHITFIELD, Kentucky MICHAEL F. DOYLE, Pennsylvania
BARBARA CUBIN, Wyoming CHRISTOPHER JOHN, Louisiana
JOHN SHIMKUS, Illinois JANE HARMAN, California
JOHN B. SHADEGG, Arizona HENRY A. WAXMAN, California
ED BRYANT, Tennessee EDWARD J. MARKEY, Massachusetts
GEORGE RADANOVICH, California BART GORDON, Tennessee
CHARLES F. BASS, New Hampshire PETER DEUTSCH, Florida
JOSEPH R. PITTS, Pennsylvania BOBBY L. RUSH, Illinois
MARY BONO, California ANNA G. ESHOO, California
GREG WALDEN, Oregon JOHN D. DINGELL, Michigan,
LEE TERRY, Nebraska (Ex Officio)
ERNIE FLETCHER, Kentucky
W.J. ``BILLY'' TAUZIN, Louisiana
(Ex Officio)
(ii)
C O N T E N T S
__________
Page
Testimony of:
Beales, J. Howard, III, Director, Bureau of Consumer
Protection, Federal Trade Commission....................... 6
Cantone, Dale E., Assistant Attorney General, Maryland
Securities Division........................................ 22
Kezios, Susan P., President, American Franchise Association.. 32
Rizer, Jerry, President, Dairy Queen Operators' Association.. 42
Wharton, Phillip Leslie, Vice President, Legal Affairs,
Franchise/License Division, Spherion....................... 28
Wieczorek, Dennis E., Partner, Piper Rudnick, on behalf of
The International Franchise Association.................... 36
(iii)
THE FTC'S FRANCHISE RULE: TWENTY-THREE YEARS AFTER THE PROMULGATION
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TUESDAY, JUNE 25, 2002
House of Representatives,
Committee on Energy and Commerce,
Subcommittee on Commerce, Trade,
and Consumer Protection,
Washington, DC.
The subcommittee met, pursuant to notice, at 10 a.m., in
room 2322, Rayburn House Office Building, Hon. Cliff Stearns
(chairman) presiding.
Members present: Representatives Stearns, Shimkus, Walden,
and Rush.
Staff present: Ramsen Betfarhad, majority counsel; Brendan
Williams, legislative clerk; and Jonathan J. Cordone, minority
counsel.
Mr. Stearns. Good morning, everybody. I am pleased to
welcome all of you to the Commerce, Trade, and Consumer
Protection Subcommittee hearing on the FTC Franchise Rule. I
wish to thank the witnesses for appearing before the committee
and look forward to their testimony.
The FTC Franchise Rule mandates a pre-sale disclosure of
certain material facts by a franchisor to a prospective
franchisee. The rule was promulgated in 1979 and has not
changed since. A lot can and does change in 23 years. During
the past 23 years, communism has all but vanished. Global trade
has expanded exponentially and the Internet has evolved from a
mere curiosity to an everyday business necessity. Yet the
Franchise Rule, the rule that regulates one of the fastest
growing and most important fields of private enterprise,
franchising, employing more than 8 million Americans and
accounting for $1 trillion in retail sales, has not changed
since its inception in 1979.
As time and circumstances have changed many argue that
through creative and sometimes not so creative interpretation
of the 1979 rule, franchisors have avoided disclosing important
facts and practices to prospective franchisees, creating cause
for consternation years later when both the franchisee and the
FTC are powerless to effectively address them. To its credit
the Commission began the process of reviewing and amending the
rule in 1997. Nevertheless, the review process has yet to reach
its fruition and yield a new Franchise Rule more responsive to
today's business reality.
Meanwhile, since 1993, 15 States have adopted the Uniform
Franchisee Offering Circular, UFOC, according greater
protection to franchisees resident in those States over those
offered by the Federal rule. The UFOC to a great extent came
about because many States concluded that the Federal Franchise
Rule was outdated and therefore less effective.
Today my colleagues will hear testimony from the Commission
as to its review efforts and its proposed amendment to the
rule. We will also hear proposed amendments offered by others,
most of which share the objective of harmonizing the FTC
Franchise Rule disclosure requirements with those of the UFOC.
I commend those efforts. I strongly encourage that the
Commission undertake its review and amending of the rule on an
expedited timetable. I also support the promulgation of a
separate rule for business opportunity franchises, as they pose
substantially different questions and challenges than business
format franchises. Amending the rule so that it better serves
its intended purpose, protection of perspective franchisees
through pre-sale disclosure of the pertinent facts about the
franchise is one thing, enforcing the rule is something
different.
The Commission reports that since the rules promulgation in
1979 it has brought over 200 franchise and business opportunity
cases under both the Rule and Section 5 of the FTC Act.
Meanwhile, just in the period 1993 to 1999 the Commission
received nearly 4,000 complaints. The question that I have for
the Commission is why so few prosecutions?
Finally, as members we are typically approached by
aggrieved franchisees, be they friends, constituents, with some
degree of frequency. Most of the issues that trouble these
franchisees arise post-sale or after the signing of the
franchise contract and, as such, don't implicate the disclosure
requirements of the FTC Franchise Rule. For example, many
franchisees have complained about the renewal and supply
sourcing policies, whether the franchisor is required to buy
all supplies from the franchisor or its designee.
Now I have had that experience myself having franchises in
which I have to buy everything from the franchisor, and then
pretty soon I end up buying the installation by the franchisor.
Moreover, the franchisees identify encroachment as yet another
contentious problem. Where a new franchisee was assigned a
franchise territory they encroached on a preexisting
franchisee's territory.
Holiday Inn sells you a franchise. You have a Holiday Inn,
and pretty soon right next to it goes a Crown Plaza. They are
upscale, and right next to it goes their budget hotel. And so
here you thought you had a franchise with Holiday Inn, you find
you have two competitors side by side, a low end and a high
end. You go to the book to look where your property is and the
three properties are there together and you thought you had it.
Or they give you a franchise and they tell you that there
will not be a franchise within 5 miles of your property. And lo
and behold, the rules change and they say, Mr. Stearns, we have
done a study which shows we are now putting another Howard
Johnson right within 3 miles of your Howard Johnson. And then I
say to them, well, that is not fair because you told me I was
going to have this. And they say, well, our rules changed
because the population density changes and that means, Mr.
Stearns, we are putting another Howard Johnson within 3 miles
of you and there is nothing in the contract that says we can't
do this. And so, lo and behold, another franchise Howard
Johnson.
It might be my friend at Chamber of Commerce, at the
Kiwanis, who sits with me at lunch who suddenly is my strong
competitor, and he is a brand new property, I am an older
property and he is now within 3 miles and, lo and behold, he
takes my business.
So I am well aware of some of those things. But these are
clearly post-sale issues not under our jurisdiction. I can
complain, can't do anything about it. Nevertheless, I wonder to
what extent can these post-sale problems be avoided and
lessened with a better disclosure rule. Some will argue that
post-sale problems cannot be effectively addressed by any
disclosure rule. That may be true--still the Commission should
strive to promulgate a new Franchise Rule that better informs a
prospective franchisee of some of the challenges such as
encroachment and renewal that he or she may face post-sale. You
can't get too much information. The person that comes in should
be more careful and that is his, the whole caveat emptor as a
franchisee. You have to assume a certain level of risk. So you
can't be a cry baby after you sign the contract and say I want
all these rules changed, because you are a big boy, you are
putting up your own money and you have to decide if you want to
go ahead with this.
If the Federal Franchise Rule is not made more effective,
more responsive to problems that plague franchisor-franchisee
relationships today, then the call by some for a Federal law
governing aspects of post-sale relationship will not subside.
After all, in the past Congress has enacted post-sale
relationship statutes applicable to the largest industries
within the franchising world, the auto and gasoline retailing.
So we have those exception. We are not suggesting that we do
that, but we do bring up at this hearing that we have these
post-sale relationship statutes in place. So we are not
suggesting it, but I think from the point of information and
from my colleagues they should realize that these statutes do
apply to auto and gasoline retailing.
So that is my opening statement, and with that I am pleased
to have an opening statement from the ranking member who is
taking Mr. Towns' place, Mr. Rush.
[The prepared statement of Hon. Clifford Stearns follows:]
Prepared Statement of Hon. Clifford Stearns, Chairman, Subcommittee on
Commerce, Trade, and Consumer Protection
Good morning. I am pleased to welcome all of you to the Commerce,
Trade and Consumer Protection subcommittee's hearing on the FTC
Franchise Rule. I wish to thank the witnesses for appearing before the
committee and look forward to their testimony.
The FTC Franchise Rule mandates a pre-sale disclosure of certain
material facts by a franchisor to a prospective franchisee. The Rule
was promulgated in 1979 and has not changed since. A lot can and does
change in 23 years. During the past twenty-three years, communism has
all but vanished, global trade has expanded exponentially, and the
internet has evolved from a mere curiosity to an everyday business
necessity. Yet the Franchise Rule, the rule that regulates one of the
fastest growing and most important fields of private enterprise
(franchising) employing more than 8 million Americans and accounting
for $1 trillion in retail sales, has not changed since its inception in
1979.
As the times and circumstances have changed, many argue that
through creative and sometimes not so creative interpretation of the
1979 rule, franchisors have avoided disclosing important facts and
practices to prospective franchisees creating cause for consternation
years later, when both the franchisee and the FTC are powerless to
effectively address them. To its credit the Commission began the
process of reviewing and amending the Rule in 1997. Nevertheless, the
review process has yet to reach its fruition and yield a new franchise
rule more responsive to today's business realities. Meanwhile, since
1993, fifteen states have adopted the Uniform Franchise Offering
Circular (UFOC) according greater protections to franchisees resident
in those states over those offered by the federal rule. The UFOC, to a
great extent, came about because many states concluded that the federal
Franchise Rule was outdated and therefore less effective.
Today, we'll hear testimony from the Commission as to its review
efforts and its proposed amendments to the Rule. We'll also hear of
proposed amendments offered by others, most of which share the
objective of harmonizing the FTC Franchise Rule disclosure requirements
with those of the UFOC. I commend those efforts. I strongly encourage
that the Commission undertake its review and amending of the Rule on an
expedited timetable. I also support the promulgation of a separate rule
for business opportunity franchises as they pose substantially
different questions and challenges than business format franchises.
Amending the Rule so that it better serves its intended purpose:
protection of prospective franchisees, through the pre-sale disclosure
of pertinent facts about the franchise is one thing. Enforcing the Rule
is something different. The Commission reports that since the Rule's
promulgation in 1979, it has brought over 200 franchise and business
opportunity cases under both the rule and section 5 of the FTC Act.
Meanwhile, just in the period 1993-99, the Commission received nearly
4000 complaints. The question that I have for the Commission is: why so
few prosecutions?
Finally, as members, we are typically approached by aggrieved
franchisees, be they friends or constituents, with some degree of
frequency. Most of the issues that trouble those franchisees arise
post-sale or after the signing of the franchise contract and as such
don't implicate the disclosure requirements of the FTC Franchise Rule.
For example, many franchisees have complained about the renewal and
supply sourcing policies (whether the franchisee was required to buy
all supplies from the franchisor or its designee) of their respective
franchisors. Moreover, the franchisees identify encroachment as yet
another contentious problem--where a new franchisee was assigned a
franchise territory that encroached on a pre-existing franchisee's
territory. These are clearly post-sale issues. Nonetheless, I wonder to
what extent can these post-sale problems be avoided or lessened with a
``better'' disclosure rule. Some will argue that post-sale problems
cannot be effectively addressed by ``any'' disclosure rule. That may be
true. Still, we, specifically the Commission, should strive to
promulgate a ``new'' Franchise Rule that better informs a prospective
franchisee of some of the challenges, such as encroachment and renewal,
that he/she may face post-sale. If the federal franchise rule is not
made more effective, i.e., responsive to problems that plague
franchisor-franchisee relations today, then the call by some for a
federal law governing aspects of post-sale relationship will not
subside. After all in the past Congress has enacted post-sale
relationship statutes applicable to two of the largest industries
within the franchising world: the auto and gasoline retailers.
Mr. Rush. Thank you, Mr. Chairman. Thank you for holding
this hearing on the FTC's Franchise Rule. There are important
questions about how this 23-year-old rule affects the industry
it regulates, as well as the efficiency of the administrative
processes at the FTC. The FTC began its review of the Franchise
Rule in April 1995. However, noticed rule changes were proposed
in 1997. That rule, however, remains unaltered even until
today.
Now, after 7 years the FTC first sought public comment
regarding amendments to the rule. Now the Commission tells us
that it will release a staff report, a staff report, I remind
you, not even a proposed final rule, by early 2003. I hope the
Commission can tell us a little bit more today about these
deliberations and shed some light on the significant delay.
The substance of the Franchise Rule also raises important
questions. The relationship between franchisees and franchisors
is unique among American businesses. As franchising becomes
more prevalent in our Nation's economy, the nature of that
relationship should be explained more closely and examined much
more closely by the FTC and by the Congress.
Are franchisees consumers of a product made by franchisors?
If so, should they receive additional consumer protections
enforced by the FTC? Or are they merely business partners whose
relationship is more appropriately governed by State contract
law? And most importantly, are potential franchisees adequately
informed about the nature of this relationship and the pitfalls
that they may face?
Today we will be hearing from representatives on both sides
of the issue as well as the FTC and State Attorney General. I
look forward to hearing their views as our subcommittee begins
its inquiry into the franchise industry.
Thank you, Mr. Chairman. I yield back the balance of my
time.
Mr. Stearns. Thank you. Mr. Shimkus for an opening
statement.
Mr. Shimkus. Thank you, Mr. Chairman, and the benefits of
small business and job creation is indisputable. However, we
have all read and heard horror stories over the years of small
business people buying into franchises and then running into a
bait and switch problem. Franchising has become a major engine
in economic growth in our country and around the world. With as
many as 8 million Americans employed by franchises, it is
important to ensure that franchisors abide by a code of
fairness and truthfulness in dealing with their franchisees.
The GAO issued a report in July 2001 on the FTC regulation
of franchising. Among its findings were that complaints by
franchisees to the FTC had risen dramatically and that 92
percent of these complaints are specifically about the post-
sale relationship. However, the FTC repeatedly complained of a
lack of resources and authority to address the post-sale
relationship issues.
I look forward to today's hearing and the panel's report
and views on what the Federal Government's role should be in
regulation of franchising and what can be done to improve the
FTC's franchising rule. Again, I thank Chairman Stearns for
holding this important consumer protection hearing, and with
that, Mr. Chairman, I yield back the balance of my time.
Mr. Stearns. I thank my colleague.
[Additional statements submitted for the record follow:]
Prepared Statement of Hon. Charles F. Bass, a Representative in
Congress from the State of New Hampshire
Mr. Chairman, I thank you for holding this hearing. I am pleased
the Subcommittee has the opportunity to revisit the issue
With 8 million Americans employed by franchises, the FTC franchise
rule is one that affects a significant segment of the population. Given
that the commission has been collecting comments since 1997 and that
the rule was promulgated 23 years ago, it is timely to consider this
disclosure rule again in light of more recent legislation and business
trends.
These relationship issues regarding policy disclosure, FTC
regulation, enforcement and even corporate governance may require
renewed consideration and deliberation and I look forward to today's
testimony.
I yield back to the Chairman.
______
Prepared Statement of Hon. W.J. ``Billy'' Tauzin, Chairman, Committee
on Energy and Commerce
Thank you, Mr. Chairman, for calling this hearing today on the
Federal Trade Commission's Franchise rule. It has been some time since
this Committee examined the guidelines set forth in the Rule, and so I
am pleased we have two distinguished panels here today to bring us up
to speed.
The ``franchise'' is one of this county's most successful business
relationships. Franchise systems continue to provide the widest
possible entrepreneurial opportunities for citizens of this country.
Today, with more than 75 industries operating within the franchising
format, franchise companies are major contributors in the development
of the management and technical skills that help to produce an
experienced work force and to support the economic vitality of this
country. There are hundreds of thousands of people who have succeeded
in this country by investing in franchises--from McDonald's
restaurants, to Hilton hotels, to 7-11 convenience stores.
As with any other business relationship, however, franchise
relationships have certainly had their share of problems. In order to
prevent abuses, the FTC implemented the Franchise Rule in 1979 to
ensure that the parties to any franchise agreement received pre-sale
disclosures of important franchise information. Today, every U.S.
franchisor must disclose certain information to prospective franchise
buyers so both parties can enter into an agreement having made informed
business decisions.
To the Commission's credit, the rules have not changed
substantially since they were first implemented. But, as Mr. Beales,
our witness from the FTC, will tell us today, the Franchise Rule covers
both franchises and so-called business opportunity enterprises. In a
business opportunity, the promoter promises to provide the buyer with
equipment, such as vending machines, used to sell products or services.
It is in the area of ``business opportunities'' that the FTC is
receiving an increasing number of complaints. Of the 170 cases the FTC
brought in 2001 under the Commission's Franchise Program, a startling
148 of those were business opportunity scams. I am heartened to see the
FTC, as the agency empowered to protect consumers against schemes
designed to separate people from their money, is taking aggressive
enforcement steps to address the growing problems seen in this area.
Since the Franchise rule has been in place for 23 years, it is
about time the Commission took a fresh look and considered appropriate
amendments. I understand that the FTC is currently in the process of
making amendments to the Franchise Rule to reflect changes in the
marketplace and to further increase the pre-sale disclosures. I look
forward to hearing about these proposed changes and the impact they
will have for both franchisees and franchisors.
I thank our witnesses for appearing here today and, again, I thank
the Chairman for holding this hearing. Thank you.
Mr. Stearns. We welcome our first witness, Mr. Howard
Beales, Director of the Bureau of Consumer Protection in the
FTC. Mr. Beales has been before us before. We welcome you, and
we look forward to your opening statement.
STATEMENT OF J. HOWARD BEALES III, DIRECTOR, BUREAU OF
CONSUMER PROTECTION, FEDERAL TRADE COMMISSION
Mr. Beales. Thank you, Mr. Chairman. It is always a
pleasure to be here, and thank you also to the members of the
subcommittee. I am pleased to be here today to discuss the
FTC's Franchise Rule. The written statement that I have
submitted represents the views of the Federal Trade Commission.
My oral statement and responses to questions are my own and not
necessarily those of the Commission or any individual
Commissioner.
The Franchise Rule seeks to facilitate informed decisions
and to prevent deception in the sale of franchises. Rather than
regulate the substance of the terms controlling the
relationship, the rule requires franchisors to provide
prospective franchisees with material information that they
need prior to the sale. As you know, the rule works in
conjunction with section 5 of the FTC Act, which prohibits
unfair and deceptive practices. The Commission aggressively
investigates and prosecutes violations of the Franchise Rule
and section 5 against franchisors and business opportunity
sellers. To date the Commission has brought over 200 such law
enforcement actions, involving over 640 entities and
individuals.
I am pleased to tell you that just last week the Commission
announced the filing of over 70 new cases by the FTC, the
Department of Justice and our State partners in a FTC
coordinated sweep against fraudulent business opportunities and
related scams. The majority of the FTC's franchise related
actions have targeted business opportunities.
As you know, the Franchise Rule generally covers two
different types of business arrangements, franchises and
business opportunity ventures. Although the Commission receives
few franchisee complaints alleging fraud, deception or
substantive rule violations by franchisors, the same cannot be
said of business opportunity sellers. Many business
opportunities are outright scams that disappear shortly after
taking consumers money.
Unfortunately, compliance with the Franchise Rule by
business opportunity sellers is low. This fact is amply
demonstrated by the analysis of our complaint data base
contained in the Commission's prepared testimony. We receive
far more consumer complaints about the sale of business
opportunities than we receive about traditional franchises. The
complaint data also indicate that unlike complaints about
traditional franchises, business opportunity fraud is a leading
cause of consumer injury.
The same pattern is evident when we examine the number of
complaints about particular sellers. Although we often receive
large numbers of complaints about a single business opportunity
scam, we rarely receive complaint from more than one franchisee
about the same franchisor. Accordingly, the Commission
continues to focus much of its Franchise Rule enforcement
resources on prosecuting business opportunity frauds.
Finally, as the subcommittee is aware, the Commission is in
the process of updating the Franchise Rule. In 1999, the
Commission published a notice of proposed rulemaking which sets
forth the text of a proposed rule. Among other things, the
proposal would review the rule in four material respects. It
would focus exclusively on franchise issues so that business
opportunities would be handled in a separate rulemaking.
Second, the proposal would revise the Franchise Rule along
the model of the uniform franchise offering circular
guidelines.
Third, the proposal would update the rule to address
franchise disclosures made via the Internet.
Finally, the proposal would provide prospective franchises
with more information about the state of the franchise
relationship.
We are hopeful of forwarding a staff report to the
Commission, which would be the next stage in this process, at
some point in the fall. That staff report would then be subject
to public comment under the FTC's procedures.
Mr. Chairman, the FTC greatly appreciates the opportunity
to testify, and I would be happy to answer any questions that
you or members of the committee may have.
[The prepared statement of J. Howard Beales III follows:]
Prepared Statement of J. Howard Beales, III, Director, Bureau of
Consumer Protection, Federal Trade Commission
Mr. Chairman, I am J. Howard Beales, III, the Director of the
Federal Trade Commission's Bureau of Consumer Protection.1
On behalf of the Commission, I appreciate this opportunity to provide
information to the Subcommittee on franchising and the Commission's
enforcement of the Franchise Rule.2 As you know, the
Commission promulgated the Franchise Rule in the late 1970s, and since
that time has rigorously enforced its provisions. Since the Franchise
Rule was enacted, the Commission has brought over 200 franchise and
business opportunity cases against over 640 entities and individuals.
Indeed, just last week, the Commission announced its seventh joint law
enforcement sweep in this field. Together with the Department of
Justice and our state partners, we have filed over 70 cases against
business opportunities and related schemes, the most prevalent and
persistent problem in Franchise Rule enforcement.
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\1\ The views expressed in this statement represent the views of
the Commission. My oral statement and responses to any questions you
may have are my own and are not necessarily those of the Commission or
any Commissioner.
\2\ Disclosure Requirements and Prohibitions Concerning Franchising
and Business Opportunity Ventures, 16 C.F.R. Part 436. The Commission
also enforces over 30 rules governing specific industries and
practices, for example: the Funeral Rule, 16 C.F.R. Part 453, which
requires funeral providers to give consumers accurate price lists that
itemize goods and services offered; and the Telemarketing Sales Rule,
16 C.F.R. Part 310, which defines and prohibits deceptive telemarketing
practices and other abusive telemarketing practices.
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The FTC's mission is to protect American consumers by taking action
against unfair or deceptive acts or practices and by promoting vigorous
competition. To that end, the Commission enforces the Federal Trade
Commission Act (``FTC Act''), which prohibits unfair methods of
competition and unfair or deceptive acts or practices in or affecting
commerce.3 The FTC Act also empowers the Commission to
prescribe rules that define with specificity acts or practices that are
unfair or deceptive.4 One such rule is the Commission's
Franchise Rule.5 Today, I will describe the Franchise Rule
and the Commission's enforcement history. I will then discuss franchise
relationship issues and the Commission's ongoing rule amendment
proceeding.
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\3\ 15 U.S.C. Sec. 45(a).
\4\ 15 U.S.C. Sec. 57a.
\5\ In many respects, franchisees are not ordinary consumers. For
example, the Magnuson-Moss Warranty Act defines ``consumer'' as ``a
buyer . . . of any consumer product.'' In turn, it defines ``consumer
product'' in relevant part as ``any tangible personal property which is
distributed in commerce and which is normally used for personal,
family, or household purposes.'' 15 U.S.C. Sec. 2301. Similarly, the
Electronic Signatures in Global and National Commerce Act, 15
U.S.C.Sec. 7001 et seq. defines ``consumer'' as ``an individual who
obtains, through a transaction, products or services which are used
primarily for personal, family, or household purposes . . .'' Id. at
Sec. 7006. Franchisees, in contrast, do not just buy products, but
invest in a business system. Indeed, several states have held that
franchisees are not ``consumers'' entitled to protection under state
general consumer protection statutes. E.g., West Coast Franchising Co.
v. WCV Corp., 30 F. Supp. 2d 49 (E.D. Pa. 1998); Sparks Tune Up Centers
v. Addison, Civ. No. 89-1355, 1989 U.S. Dist. LEXIS 7413 (E.D. Pa.
1989)(applying Ohio law). This view, however, is not universal. See,
e.g., Hofsettler v. Fletcher, 905 F.2d 897 (6th Cir. 1988); Deerman v.
Fed. Home Loan Mortg. Corp., 955 F. Supp. 1393 (N.D. Ala. 1997); LJS
Co. v. Marks, 480 F. Supp. 241 (S.D. Fla. 1979).
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i. background
A. The Franchise Rule Provides Important Information And Prohibits
Deceptive Practices
When the Commission promulgated the Franchise Rule in the 1970s,
the Commission determined that prospective franchisees needed certain
critical information from franchisors. Without adequate information,
prospective franchisees risked serious economic injury as a result of
misrepresentations or omissions of material facts about the franchise
business under consideration. Prevalent deceptive practices included
the misrepresentation of: (1) the nature of the franchise; (2) the
range of goods and services, such as supplies, equipment, and training,
to be provided as part of the franchise package; (3) the value and
profitability of the franchise; and (4) the franchisor's financial
stability and prior experience.6
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\6\ See Franchise Rule Statement of Basis and Purpose, 43 Fed. Reg.
59,614, 59,624-632 (Dec. 21, 1978).
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The Franchise Rule seeks to facilitate informed decisions and to
prevent deception in the sale of franchises by requiring franchisors to
provide prospective franchisees with material information prior to the
sale. Specifically, the Franchise Rule requires franchisors to make
material disclosures in five categories: (1) the nature of the
franchisor and the franchise system; (2) the franchisor's financial
viability; (3) the costs involved in purchasing and operating a
franchised outlet; (4) the terms and conditions that govern the
franchise relationship; and (5) the names and addresses of current
franchisees who can share their experiences within the franchise
system, thus helping the prospective franchisee to verify independently
the franchisor's claims. In addition, franchisors must have a
reasonable basis and substantiation for any earnings claims made to
prospective franchisees, as well as disclose the basis and assumptions
underlying any such earnings claims.
B. The Franchise Rule Covers Sales Of Franchises And Business
Opportunity Ventures
The Franchise Rule generally covers two different types of business
arrangements: 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, hotels, and automotive repair shops. These are
commonly known as ``business-format'' franchises.7 Business
opportunities, on the other hand, often do not entail a trademark or
detailed business plan. In a business opportunity, the promoter
typically promises 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. The business
opportunity promoter also frequently promises 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 rack displays in airports or bowling alleys, or
providing the names of doctors seeking medical billing assistance.
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\7\ The Franchise Rule also covers ``product franchises,'' in which
the franchisee typically distributes products manufactured by the
franchisors, such as automobile dealerships. See Franchise Rule, Final
Interpretive Guides, 44 Fed. Reg. 49,966, 49,966-967 (Aug. 24, 1979).
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C. Fifteen States Also Have Franchise Disclosure Laws
The FTC is not the only governmental entity to address pre-sale
disclosure of franchise information. In addition to the FTC, 15 states
require pre-sale disclosure in franchise sales in the form of a Uniform
Franchise Offering Circular (``UFOC'').8 In many respects,
the UFOC Guidelines' required disclosures are substantially similar to
those of the Franchise Rule. Both formats, for example, require a
description of: (1) the franchisor and its business; (2) prior
litigation and bankruptcies; (3) initial and ongoing fees; (4)
franchisor and franchisee obligations and other terms of the franchise
contract; (5) restrictions on sales; and (6) rights to renew and
terminate the franchise. In addition, both formats require
substantiation of any earnings claims, statistics on existing
franchisees, a list of franchisee references, and audited financial
statements.9(3) computer system requirements; and (4) the
names and addresses of former as well as current franchisees.
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\8\ These states are California, Hawaii, Illinois, Indiana,
Maryland, Minnesota, Michigan, New York, North Dakota, Oregon, Rhode
Island, South Dakota, Virginia, Washington, and Wisconsin. Twelve of
these states review and approve franchisors' UFOCs before they can be
used in the state. In order to reduce franchisors' compliance burdens,
the Commission will accept a UFOC in lieu of a franchise disclosure
document.
\9\ The UFOC Guidelines, however, focus exclusively on franchise
sales; business opportunities are regulated to varying degrees in 22
states. The UFOC Guidelines also contain more expansive disclosures
than the Franchise Rule. For example, the UFOC Guidelines require the
disclosure of: (1) regulations specific to the industry in which the
franchisee will conduct business; (2) litigation or a bankruptcy
involving a franchisor's predecessor;
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Because a UFOC is accepted by both the states and the FTC, the UFOC
Guidelines have effectively become the national franchise disclosure
standard.
ii. franchise rule enforcement
The Franchise Rule has the force and effect of law, and it may be
enforced through civil penalty actions in federal courts.10
The FTC Act authorizes courts to impose civil penalties of not more
than $11,000 per compliance violation. In addition, the Commission may
seek to obtain preliminary and permanent injunctive relief (including
the full range of equitable remedies) in federal court.11
Such actions often result in monetary redress made to injured
consumers.
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\10\ 15 U.S.C. Sec. 45(m)(1)(A).
\11\ 15 U.S.C. Sec. 53(b).
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To date the Commission has brought over 200 law enforcement actions
under the Franchise Rule and Section 5 of the FTC Act against
franchisors and business opportunity ventures, involving over 640
entities and individuals. Many of those actions have been against well-
known franchise systems. For example, the Commission brought suit
against Minuteman Press, a national printing franchisor.12
That case, which involved a six-month trial, resulted in a settlement
in which the defendants paid over $3 million in consumer redress.
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\12\ FTC v. Minuteman Press, Int'l, Civ. No. CV-93-2496
(DRH)(E.D.N.Y. 1993). See also, e.g., FTC v. Car Wash Guys, Int'l,
Inc., Civ. No. 00-8197 (C.D. Cal. 2000); FTC v. Tower Cleaning Sys.,
Inc., Civ. No. 96-58-44 (E.D. Pa. 1996); U.S. v. Tutor Time Child Care
Sys., Inc., Civ. No. 96-2603 (N.D. Cal. 1996); FTC v. Indep. Travel
Agencies of Am. Assoc., Civ. No. 95-6137-CIV-Gonzalez (S.D. Fla. 1995);
FTC v. Mortg. Serv. Assoc., Civ. No. 395-CV-1362 (AVC) (D. Conn. 1995);
U.S. v. Jani-King Int'l, Inc., Civ. No. 3-95-CV-1492-G (N.D. Tex.
1995).
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A. Distinctions Between Business-Format Franchisors And Business
Opportunity Sellers
Our law enforcement experience shows that business-format
franchising has matured since the promulgation of the Franchise Rule in
the 1970s.13 Many franchise systems today are established,
well-respected, household names.14 While there is no
question that 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. Where Rule violations occur,
it is mostly among small, start-up franchisors who may not be well-
versed in the Franchise Rule's disclosure requirements.15 As
a result, the Commission receives few franchisee complaints alleging
fraud, deception, or substantive Rule violations by business-format
franchisors.
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\13\ Since the promulgation of the Franchise Rule and the UFOC
Guidelines in the 1970s, no additional state has sought to adopt
franchise disclosure regulation. Indeed, several states, including
Michigan, Wisconsin, and Indiana, have eliminated routine review of
UFOC filings.
\14\ The franchise legal community is also well-organized. For
example, the American Bar Association's Forum on Franchising has nearly
600 members. Franchisors are also represented by the International
Franchise Association (``IFA'') and the National Franchise Council.
Franchisees are represented by various groups including the IFA,
American Franchisee Association, and American Association of
Franchisees and Dealers. In addition, we have recently seen the growth
of franchisee councils and independent franchisee associations that
represent franchisee interests, such as the National Franchise
Association (the association of Burger King franchisees).
\15\ In such instances, the FTC staff may recommend that the
alleged violation be addressed through a referral to the National
Franchise Council (``NFC''), a private industry group comprised of a
limited number of select franchise systems, mostly in the hotel and
food industries. Franchisors who agree to be referred to the NFC's
Alternative Law Enforcement Program receive Franchise Rule compliance
training, compliance monitoring, and in, some instances, participate in
mediation of franchisee complaints. This approach to addressing minor,
non-fraudulent violations of the Franchise Rule is consistent with the
goals of the Small Business Regulatory Fairness Enforcement Act, 5
U.S.C. Sec. 601, et seq., which, among other things, requires agencies
to consider reducing or waiving civil penalties in appropriate
circumstances.
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Unfortunately, the same cannot be said of business opportunity
sellers. Many business opportunities are outright scams that disappear
shortly after taking consumers' money. Compliance with the Franchise
Rule by business opportunity sellers is low. A 2001 Staff Review of the
Commission's Franchise Program reported that the Commission brought 170
franchise or business opportunity cases against 330 entities and 305
individuals between 1993 and 2001.16 Of the 170 cases, 148
were against business opportunity schemes.17 Commission
actions have involved, for example, the deceptive sale of vending
machine 18 and rack display 19 opportunities; pay
telephones, 20 fax, 21 and Internet access
22 ventures; 900-number telephone schemes; 23 and
medical billing opportunities.24 Almost all of these cases
involved the making of false or unsubstantiated earnings
representations in violation of the Rule and most alleged that the
promoter failed to provide prospects with any disclosures whatsoever.
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\16\ Bureau of Consumer Protection Staff, Franchise and Business
Opportunity Program Review 1993-2000 (June 2001)(``Staff Review'') at
33. A copy of this Staff Review is available at the Commission's Web
site at: http://www.ftc.gov/bcp/reports/franchise9301.pdf.
\17\ Similarly, in its 2001 audit of the Commission's Franchise
Program, the General Accounting Office (``GAO'') found that, between
1993 and 2000, the Commission staff opened 332 franchise and business
opportunity investigations, the overwhelming majority of which involved
business opportunities. GAO, Federal Trade Commission Enforcement of
the Franchise Rule (July 2001)(``GAO Report'') at 13-15. See also
Appendix V: Information on Business Opportunity and Franchise Court
Cases Filed by FTC During 1993-2000, id. at 49-64.
\18\ See, e.g., FTC v. Pathway Merch., Inc., Civ. No. 01-CIV-8987
(S.D.N.Y. 2001); FTC v. Hi Tech Mint Sys, Inc., Civ. No. 98 CIV 5881
(S.D.N.Y. 1998); U.S. v. PVI, Inc. Civ. No. 98-6935 CIV-Ferguson (S.D.
Fla. 1998); FTC v. Telecard Dispensing Corp., Civ. No. 98-7058-CIV
(S.D. Fla. 1998); FTC v. Hi Tech Mint Sys., Inc., Civ. No. 98-CIV-5881
(N.D.N.Y. 1998); FTC v. Vendall Mktg. Corp., Civ. No. 94-6011-HO (D.
Or. 1994); FTC v. Vendorline, Inc., Civ. No. 2:92-cv-129-WCO (N.D. Ga.
1992). See also FTC News Release: FTC Announces Operation ``Vend Up
Broke'' (Sept. 3, 1998)(FTC and 10 states announce 40 enforcement
actions against fraudulent vending business opportunities).
\19\ See, e.g., U.S. v. QX Int'l, Civ. No. 3:98CV453-D (N.D. Tex.
1998); FTC v. Carousel of Toys, Civ. No. 97-8587 CIV-Ungaro-Benages
(S.D. Fla. 1997); FTC v. Urso, Civ. No. 97-2680 CIV-Ungaro-Benages
(S.D. Fla. 1997); FTC v. Infinity Multimedia, Inc., Civ. No.
966671CIVGonzalez (S.D. Fla. 1996); FTC v. Andrisani, Civ. No. 93-6511
(S.D. Fla. 1993). See also FTC News Release: Display Racks for Trade-
Named Toys and Trinkets are the Latest in Business Opportunity Fraud
Schemes (Aug. 5, 1997)(FTC and eight states file 18 enforcement actions
against sellers of bogus business opportunities that use trademarks of
well-known companies).
\20\ See, e.g., FTC v. Advanced Pub. Communications Corp., Civ. No.
00-00515 CIV-Ungaro-Benages (S.D. Fla. 2000); FTC v. Ameritel Payphone
Distrib., Inc., Civ. No. 00-0514 CV-Gold (S.D. Fla. 2000); FTC v.
ComTel Communications Global Network, Inc., Civ. No. 96-3134-CIV-
Highsmith (S.D. Fla. 1996); FTC. v. Intellipay, Inc., Civ. No. H92-2325
(S.D. Tex. 1992).
\21\ See FTC v. Fax Corp. of Am., Inc., Civ. No. 90-983 (D. N.J.
1990).
\22\ See FTC v. Hart Mktg Enter., Civ. No. 98-222-Civ-T-23E (M.D.
Fla. 1998). See also FTC v. FutureNet, Inc., Civ. No. CV-98-1113 GHK
(BQRx) (C.D. Cal. 1998); FTC v. TouchNet, Inc., Civ. No. C98-0176 (W.D.
Wash. 1998).
\23\ See, e.g., FTC v. Bureau 2000 Int'l, Inc., Civ. No.
961473DT(JR) (C.D. Cal. 1996); FTC v. Genesis One Corp., Civ No.
CV961516MRP(MCX) (C. D. Cal.1996); FTC v. Innovative Telemedia, Inc.,
Civ. No. 968140 CIVFerguson (S.D. Fla. 1996).
\24\ See, e.g., FTC v. Medicor LLC, Civ. No. CV01-1896 (CBM) (C.D.
Cal. 2001); FTC v. Vaughn William, III, Civ. No. 00-01083 (C.D. Cal.
2000); FTC v. Data Med. Capital, Inc., Civ. No. SACV991266 AHS (C.D.
Cal. 1999); FTC v. Nat'l Consulting Group, Inc., Civ. No. 98 C 0144
(N.D. Ill. 1998); FTC v. Marquette, Inc., Civ. No. 1:95-CV-1749-RLV
(N.D. Ga. 1997); U.S. v. Island Automated Med. Serv., Inc., Civ. No.
95-1110-CV-T-17(A) (M.D. Ga. 1995).
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In addition to violating the Franchise Rule, business opportunity
sellers also frequently engage in a myriad of deceptive acts and
practices in violation of Section 5 of the FTC Act in order to lure
unsuspecting consumers to invest. For example, business opportunity
sellers often disseminate false earnings projections and make false
promises of exclusive market territories. In addition, they often use
shill references or false testimonials to create the impression that
their opportunity is safe and profitable. Typically, they also
misrepresent the availability or profitability of locations for vending
machines or other equipment used in the business; misrepresent their
prior success; misrepresent assistance to be provided to the purchaser;
and misrepresent the nature of their products or services.25
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\25\ Staff Review at 37-39.
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B. The Commission's Law Enforcement Efforts Track Consumer Complaint
Data
The Commission's law enforcement efforts described above track the
breakdown of complaints the FTC receives. Overwhelmingly, the
complaints the Commission receives involve the sale of business
opportunities. The Commission's staff analyzed 4,512 franchise and
business opportunity complaints in the Commission's Consumer
Information System (``CIS'') database between 1993 and June 1999. Of
the 4,512 complaints, 3,392 complaints--more than 75%--clearly involved
business opportunities. An additional 832 complaints were against
companies that did not appear on known lists of franchisors and most
likely were business opportunities as well.26 Only 6% of the
complaints pertained to traditional franchise arrangements. Complaints
were lodged against 949 business opportunity sellers, but against only
197 franchisors.
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\26\ Id. at 4-9.
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Injury to individual consumers resulting from business opportunity
fraud is also among the highest levels of injury we see in consumer
protection. The staff's analysis of complaint data between 1993 and
June 1999 shows that more than 650 consumers each reported losses of at
least $10,001. An additional 631 consumers each reported losses of
between $5,001 and $10,000, and 621 between $1,001 and
$5,000.27 Indeed, injury from business opportunity fraud
consistently ranks among the top 10 product/service categories in the
Commission's database based upon amount paid, often resulting in
consumer losses of over $1 million each month.
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\27\ Id. at 17 (Chart C.5). The level of actual injury is probably
much greater. Our review found that 727 business opportunity purchasers
did not disclose how much they believed was lost through their
investment. See Id. (Chart C.6).
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For these reasons, the Commission continues to focus much of its
Franchise Rule enforcement and consumer educational resources
28 on combatting business opportunity fraud. Indeed, since
1995, the Commission has joined with the Department of Justice and
state consumer protection agencies to bring seven joint law enforcement
sweeps covering a variety of business opportunity ventures. The most
recent of these sweeps occurred just last week--Operation Busted
Opportunity, which targeted over 70 business opportunity and related
schemes.
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\28\ In addition to law enforcement, the Commission has engaged in
numerous consumer educational efforts to spread the word about business
opportunity and related frauds. For example, the Commission's Office of
Consumer and Business Education (``OCBE'') has generated nearly 20
brochures and alerts on various business opportunities and related
schemes (multi-level marketing, pyramids, work-at-home schemes). In
fiscal year 2000 alone, OCBE distributed 169,120 printed copies of
these materials and received 374,787 hits on its online versions. Staff
Review at 61.
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The Commission will continue to work with its law enforcement
partners to protect consumers from such frauds.
iii. franchise ``relationship'' issues
One area of franchising that has received widespread attention in
recent years is the nature of franchise relationships. The Franchise
Rule requires the disclosure of material information concerning the
sale of a franchise. It does not, however, regulate the substance of
the terms that control the relationship between franchisors and
franchisees. The Commission believes that the market is the best
regulator of franchise sales, provided that prospective franchisees
have full and complete disclosure of material information with which to
conduct a due diligence investigation of the franchise offering.
Nonetheless, we are aware that some franchisees, franchisee trade
associations, and franchisee advocates have raised concerns about
franchise relationships. Their concerns do not involve allegations of
deception or fraud in the sale of franchises. Rather, they assert that
the underlying relationship between franchisor and franchisee is often
unfair, with the franchisor dictating the terms under which the
franchisee will conduct business, often allegedly resulting in
significant financial losses. Among other issues, franchisees have
complained about: (1) lack of protected territories and encroachment by
franchisors into their market location; (2) obligations to purchase
supplies or inventory from specified providers, even if comparable
items are available at cheaper prices from alternative suppliers; and
(3) renewal of franchise agreements on restrictive or more onerous
terms.29
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\29\ The Franchise Rule (as well as the UFOC Guidelines) addresses
each of these issues through pre-sale disclosure. See 16 C.F.R.
Sec. 436.1(a)(13)(territorial protections); Sec. 436.1(a)(10) (required
suppliers); Sec. 436.1(a)(11)(revenue received by franchisor from
required suppliers); Sec. 436.1(a)(15)(renewal and termination
conditions).
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A. The Commission Lacks Complaint Data that Would Indicate Franchise
Relationship Disputes Are a Prevalent Problem
Although the Commission does not doubt that individual franchisees
may have experienced abuses in their relationships with franchisors,
the Commission is unaware of any evidence that relationship issues are
prevalent throughout franchising. As a preliminary matter, we do not
know the exact number of franchisees in the United States. In its 2001
report on the Franchise Rule, the GAO stated that there are more than
320,000 franchised units in the United States.30
Accordingly, we can reasonably assume that there are hundreds of
thousands of franchisees. Yet, FTC complaint data for the period 1993
through June 1999 show that only 288 franchisees filed complaints with
the Commission. Of these, 134 contained insufficient information to
determine any specific allegation. Of the remaining 154 complaints, 141
raised post-sale issues involving 102 companies.31 It
appears that franchisees in about 95% of the approximate 2,500
franchise systems operating in North America 32 did not file
a single relationship complaint with the Commission during nearly seven
years.33 Moreover, the vast majority of companies that were
the subject of a franchise complaint generated only a single complaint.
For example, 91 companies generated only one complaint each, while only
one company generated more than five complaints. In short, complaints
to the Commission rarely present a pattern of law violations by
business-format franchise systems.34
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\30\ GAO Report at 5.
\31\ See Id. at 22.
\32\ See Bond's Franchise Guide (1998 ed.) at 9, 25 (estimating
there are 2,500 American and Canadian franchisors).
\33\ The complaint data noted above do not necessarily represent an
exact accounting of all correspondence that was submitted to the
Commission during the relevant time period. As noted in the Staff
Review, complaint data prior to 1997, especially telephone calls, were
not routinely captured in a centralized database. This changed in 1997,
when the Commission created the Consumer Response Center, which
standardized Commission complaint handling. For these reasons, data
submitted to the Commission after 1996 is the most complete.
Nonetheless, the CIS data analyzed in the Staff Review are the single
best source of complaint information available to the Commission both
before and after 1997. See Staff Review at 4.
\34\ It is possible that franchisees may have complained to state
agencies. However, as noted below, the GAO found that the states
contacted during its audit did not have readily available and
statistically reliable data on the extent and nature of franchise
relationship problems. Also, to the extent that states contribute data
to the Commission's Consumer Sentinel database, franchisee complaint
information to the states would have been included in the complaint
data analyzed by the Commission's staff.
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The lack of relationship complaints in business-format franchising
is consistent with the findings of the GAO. After conducting an inquiry
into the scope of franchise relationship issues, the GAO concluded:
The extent and nature of franchise relationship problems are
unknown because of a lack of readily available, statistically
reliable data--that is, the data available are not
systematically gathered or generalizable. According to FTC
staff, data FTC has collected, while limited, suggest that
franchise relationship problems are isolated occurrences rather
than prevalent practices. Franchise trade association officials
pointed to indicators or anecdotal information to support their
views regarding franchise relationship problems, but they were
not aware of any statistically reliable data on the extent and
nature of these problems. Likewise, none of the nine states we
contacted--eight of which have franchise relationship laws--had
readily available, statistically reliable data on the extent
and nature of franchise relationship problems.35
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\35\ GAO Report at 4 and 21.
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B. Franchise Relationship Issues Are Determined by State Contract Law
Franchise relationship issues are generally governed by the private
contractual relationship between the franchisor and franchisee. To the
extent that there are contract disputes, these are appropriately
resolved under applicable state law. As noted above, the Franchise Rule
is designed to ensure that franchisees have time to review all material
terms and conditions of the franchise relationship, and an opportunity
to seek legal, accounting, and marketing advice as well as the
opportunity to speak to both former and current system franchisees
before entering into a franchise agreement.
It has been suggested by some that the Commission could use its
unfairness authority to address franchise relationship issues. However,
the Commission's unfairness authority is limited. Economic injury to
franchisees alone is insufficient. Section 5 of the FTC Act provides
that the Commission does not have the authority to declare an act or
practice unfair unless it meets three specific criteria: (1) the act or
practice causes or is likely to cause substantial injury; (2) that is
not outweighed by countervailing benefits to consumers or to
competition; and (3) is not reasonably avoidable.36
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\36\ This definition of unfairness was codified by Congress in the
1994 amendments to the FTC Act at 15 U.S.C. Sec. 5(n). See also Orkin
Exterminating Co., 108 F.T.C. 263, aff'd Orkin Exterminating Co. v.
FTC, 849 F.2d 1354, reh'g denied, 859 F.2d 928 (11th Cir. 1988), cert.
denied, 488 U.S. 1041 (1989).
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Even where there is substantial injury to franchisees, the second
and third criteria must be met. Franchise systems, like all businesses,
are influenced by ordinary market forces, and franchisors may want
franchise agreements that maximize their ability to respond quickly to
market changes. Therefore, a franchisor's choice of contract terms and
conditions is often based upon some economic rationale that is designed
to benefit consumers and/or the system's existing franchisees. The
benefits flowing from these contractual terms may outweigh complaints
or allegations of ``oppression'' by individual complainant-franchisees.
Further, the Commission would be required to establish that
contractual provisions that prospective franchisees voluntarily read,
agreed to, and signed are not reasonably avoidable. This would be
difficult because, under the Franchise Rule, prospective franchisees
receive a disclosure document at least 10 business days before they are
required to sign the franchise agreement. Presumably, every prospective
franchisee also has the opportunity to review the franchise agreement
before signing, seek legal, accounting, and marketing advice, as well
as to speak to both former and current system franchisees. In short, it
would not be appropriate for the Commission to second-guess a
prospective franchisee's wisdom in signing a particular franchise
agreement, as long as the prospective franchisee is forewarned about
the legal consequences of his or her actions.
iv. rulemaking
As the Subcommittee is probably aware, the Commission is in the
process of updating the Franchise Rule.37 In 1999, the
Commission published a Notice of Proposed Rulemaking (``NPR''), which
set forth the text of a proposed revised Rule. Among other things, the
proposal would revise the Rule in four material respects. First, it
would focus exclusively on franchise issues. In the NPR, the Commission
proposed that business opportunities be addressed in a separate
rulemaking procedure that would focus narrowly on appropriate
disclosures and, more importantly, on prohibitions necessary to prevent
persistent fraud in that area. Second, the proposal would revise the
Franchise Rule along the UFOC Guidelines model. This would reduce
inconsistencies between federal and state disclosure laws and reduce
compliance burdens. Third, the proposal would update the Rule to
address new technologies, in particular the sale of franchises through
the Internet. Fourth, the proposal would provide prospective
franchisees with more information about the state of the franchise
relationship. While specific complaints by franchisees are relatively
few, as noted above, there remains considerable support among
franchisee associations and franchisee advocates for greater disclosure
of information from which a prospective franchisee can assess the
quality of the relationship he or she will be entering.
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\37\ The rule amendment process began with a review of the Rule in
1995, 60 Fed. Reg. 17,656 (April 7, 1995), and was followed by the
publication of an Advance Notice of Proposed Rulemaking in 1997, 62
Fed. Reg. 9,115 (February 28, 1997), and a Notice of Proposed
Rulemaking in 1999, 64 Fed. Reg. 57,294 (October 22, 1999).
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The next step in the rule amendment process is the publication of a
staff report that analyzes the record to date and offers specific
recommendations for further fine-tuning of the NPR proposal. Because
the rulemaking is ongoing, we cannot, at this time, comment on any
substantive aspect of the proposed rule or its implementation.
Nonetheless, we note that several NPR proposals, if ultimately adopted
by the Commission, would give prospective franchisees expanded
information with which to assess the franchise offering and the
relationship between the franchisor and franchisee. For example, these
proposals would: (1) alert prospective franchisees about the
availability of the Commission's Consumer Guide to Buying a Franchise,
which contains advice on how to read a disclosure document; (2)
increase franchisors' disclosures about prior litigation with
franchisees; (3) warn prospective franchisees about the consequences of
purchasing an unprotected territory and not to rely on unauthorized
financial performance information; and (4) make available information
about franchisor-sponsored and independent franchisee associations.
v. conclusion
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. The
Commission will continue to dedicate significant law enforcement
resources to targeting this problem, as well as consider promulgating a
separate business opportunity trade regulation rule that will prohibit
specific practices that often underlie fraudulent business opportunity
schemes.
Thank you for this opportunity to describe for the Committee the
Commission's Franchise Rule program. I will be pleased to respond to
your questions.
Mr. Stearns. I thank you, Mr. Beales. It is interesting, I
don't even think most franchisees know that they can even
complain to the FTC. And how do you get the word out? I mean
how are people to know that you are an agency to complain to
before they sign their contracts, not post-contract?
Mr. Beales. Well, we do a fair amount of general promotion
of our complaint number, which is 1-877-FTC-HELP, as just sort
of general promotion for all sorts of complaints, and we
clearly get large numbers of business opportunity complaints.
Mr. Stearns. No, I know that.
Mr. Beales. Simply not from franchisees. We also, a lot of
the complaints in our data base come from other organizations.
We have tried to negotiate complaint sharing arrangements with
other law enforcement entities and with other regulators so
that when, for example, for many Better Business Bureaus, if a
complaint goes to the Better Business Bureau, that complaint
also is automatically entered into our data base.
So we try to reach out to get complaints. But there also
may be, are many complaints that don't come to us or that don't
go anywhere.
Mr. Stearns. I think that is what happened. You know, like
in Florida, if you sign a realtor contract for a home or you
sign a realtor contract for renting of an apartment, there is a
little box close to your signature that says that if you have
any concern or questions call the Consumer Affairs of Florida,
Department of Commerce. Do you think something like that should
apply before you sign a franchisee agreement, that there should
be some kind of regulation that says in the event that you are
not happy, that we will go ahead--I mean, you can call the FTC,
you know, just to notify the franchisee that he doesn't have to
run to a lawyer and sue because that is what most of them want
to do and most of these folks don't have the money to sue? So,
you know, is it possible that you need to get the word out a
little bit better?
Mr. Beales. Well, in the disclosure document that is given
to franchisees prior to the sale, there is a reference to the
FTC that identifies us as the place to complain.
Mr. Stearns. With a phone number. With a toll free number?
Mr. Beales. I don't know if the phone number is there or
not. I would have to check as to whether the disclosure
specifically includes that.
Mr. Stearns. There is not a specific box that they can
focus on. It just says you can contact the Federal Trade
Commission. Federal Trade Commission is not known to most small
business people. Who knows where, what, what it is. For all
intents and purposes it could be in Afghanistan. I mean they
just don't even know. I have got here my staff showing--it says
franchisor, Pizza Hut, Incorporated. Information for a
prospective franchisee is required by the Federal Trade
Commission. But it doesn't necessarily say that in the event
that you want to complain--Okay. The Federal Trade Commission,
Washington, DC. Okay, well, just something to think about.
Mr. Beales. One of the things that is in the proposed rule,
in the proposed changes is some changes in that identification
of the FTC and, among other things, what those changes would do
to direct prospective franchisees to our consumer education
materials that are available both in hard copy and on our Web
site which would presumably also help to identify us as the
place to complain because you can, in fact, go back to that Web
site and complain.
Mr. Stearns. And the Federal Trade Commission is a huge
government agency. It would be better to say the Federal Trade
Commission, Consumer Protection, so when they call they have a
specific number that goes right to the people and not through
the computer operated things that says dial 3 for this and dial
4 for that.
Mr. Beales. Right.
Mr. Stearns. And the GAO, the GAO in it's July 2000 report
noted that of the 79 investigation files closed between 1997
and 1999, only two contained notes explaining why they were
closed, and the question is why? So----
Mr. Beales. Well, what the practice had been, and frankly,
as I looked at the GAO report, which was one of the first
things I handled when I came to the FTC, I thought they had a
good point, that we should do a better job of documenting the
reasons that we are closing investigations. What the practice
had been, and often is, as we develop a sweep is we may open an
investigation of a potential target that would be part of a
sweep of franchises and business opportunities and then refer
that case to another enforcement partner, so that somebody else
actually brings the case. And what we would do in this case is
we would have opened it, but then we fairly promptly close the
investigation. What we were not doing was documenting the
reasons for closing or the fact of the referral, and we are
doing that now.
Mr. Stearns. Okay. You mentioned in your opening statement
about most of the business deceit has been promulgated in the
business opportunity offerings and that you are looking at
rulemaking dealing with that. You are simply going to provide a
more tailored disclosure rule to address business
opportunities, I think you indicated. Given the difficulties in
regulating and controlling business opportunity scams,
especially today with what we have on the Internet, Internet
based, tell me how this new rule is going to apply to fix this
problem. You know, moving from one disclosure requirement to
another, is that going to solve the problem? I mean, can you be
more specific?
Mr. Beales. Well, we do not have at this point a specific
proposal. It is something that I have begun talking with the
staff about, about what could we do here. I think the
fundamental problem in business opportunities is really an
enforcement one because we find most of the business
opportunities that we pursue, they are covered by the Franchise
Rule. They are not in compliance. And the question is can we
identify specific practices that would simply make our
enforcement job easier. I think it is harder, the strategy in
the Franchise Rule itself, for franchisees to provide
information. Franchisees can then avoid difficulties in many
instances and know what they are getting into. The difficulty
in business opportunities is the information is frequently not
provided in the first place, even though there is an existing
requirement to do so.
So what we would like to do is to try to develop more
tailored provisions, if we can, that would make the enforcement
burden easier and make it cheaper for us to bring cases
essentially. But there will remain an enforcement issue because
that is the nature of the business opportunity beast in many
cases.
Mr. Stearns. Should Internet based business opportunity
offerings be governed by a specific statute in the same manner
that the franchisee-franchisor relationships of the auto and
petroleum industries are?
Mr. Beales. I don't think we have seen any need for that at
this point.
Mr. Stearns. Because you are saying its in the front end
then. You don't think its in the post----
Mr. Beales. Well, the problem in most of the business
opportunity cases we bring is there is no post.
Mr. Stearns. Right.
Mr. Beales. It is ``take the money and run'' kind of scams.
Mr. Stearns. Okay. Good. Yeah.
MR. Beales. And hence we don't see a post-sale sort of
problem in a lot of cases.
Mr. Stearns. I see. So would you have to say yes or no to
that question, that the Internet based--would you put a statute
in the Internet business opportunities, a statute similar to
the franchisee-franchisor or relationships to the auto and
petroleum industry. Do you think yes or no to that?
Mr. Beales. I would say no. I think the problems we have
seen and we certainly have seen the problems of business
opportunities promoted on the Internet, but we have been quite
able to reach those problems under our existing authority.
Mr. Stearns. Okay, thank you. My time has expired. Mr.
Rush.
Mr. Rush. Thank you, Mr. Chairman. Mr. Beales, under the
rule are franchisors required to sign the disclosure documents
that they provide to potential franchisees? In other words, do
franchisors have to warrant or certify that the information in
their disclosure documents is truthful, complete and not
misleading?
Mr. Beales. I think if the information is not truthful and
complete or is misleading, that that would very clearly be a
rule violation.
Mr. Rush. So are they required to sign the disclosure
documents that they provide?
Mr. Beales. One of the things that is in the proposal would
clarify that they can't try to waive liability for statements
that are made in the disclosure document.
Mr. Rush. So until--you haven't proposed the rule or the
rule hasn't been finalized?
Mr. Beales. That is right.
Mr. Rush. Okay. So under the current status, are they
required now today to sign?
Mr. Beales. No, I don't believe they are. We think they are
responsible and reinforce the rule that way.
Mr. Rush. That is the way you enforce the rule?
Mr. Beales. Yes. I mean, if there are statements made in
the franchise disclosure documents that are not accurate, that
is a rule violation.
Mr. Rush. Okay, and what about being complete?
Mr. Beales. Complete within the sense of the information
that the rule requires to disclose, yes. If it doesn't include
that information, that too is a rule violation and we enforce
the rule that way.
Mr. Rush. Does the FTC ever review or approve the
disclosure documents it requires franchisors to give potential
franchisees?
Mr. Beales. We review them in particular investigations. We
don't review them before the fact.
Mr. Rush. Okay, so you don't approve them either?
Mr. Beales. No. That is correct. We don't. A number of
States do that under the Uniform Franchise Offering Circular,
which in some States is filed and preapproved, but the FTC does
not do that.
Mr. Rush. Should it be permissible for a franchisor to
state in a disclosure document that a franchise may be renewed
even if the franchisee is required to sign a new agreement
under different terms and conditions in order to do so?
Mr. Beales. Well, I think what the franchisor states in the
disclosure document must be an accurate reflection of what are
the renewal terms of the contract. And if the renewal terms--
and you can imagine a wide range of possibilities there. If the
renewal terms specify that you can renew this contract on these
terms, then that is what the disclosure document better say.
Mr. Rush. And so the fact that the contract can be renewed
should also be explicit in the contract? Is that what you are
saying?
Mr. Beales. Most franchise contracts do have a renewal
clause or renewal terms under which they can be renewed.
Mr. Rush. Given the current resources and obligations of
the FTC, do you think that it would be helpful for franchisees
to have a private right of action against violators of the
Franchise Rule?
Mr. Beales. Well, we have not seen very often instances of
violations of the rule that were substantive violations. We
have brought those cases. What we have seen more often is
narrow technical violations where we have developed a referral
program to bring people into compliance and to avoid future
difficulties. In many circumstances that would violate the rule
the franchisee probably has a private right of action under the
contract that would--because something in the disclosure
document doesn't accurately reflect what was in the contract.
So there may well be a private right of action there as well.
Mr. Rush. So you don't think that should be explicit?
Mr. Beales. No, sir, I don't. I don't. There is in
general--under all of the FTC's rules there is not a private
right of action or under the FTC Act itself.
Mr. Rush. Okay. Mr. Beales, can you explain why the FTC has
taken so long to amend this rule?
Mr. Beales. Well, I think it has primarily been a question
of priorities. Most of the amendments are to conform the rule
to the Uniform Franchise Offering Circular. But the FTC has
always recognized compliance with the UFOC as compliance with
the Franchise Rule. So as a practical matter, people who want
to comply that way, and as a practical matter most franchisors
do if they are national franchisors, they already can. We ought
to clean up the rule. We ought to conform the rule, but the
benefits from doing so are smaller than they might be in a
different arrangement where we didn't recognize compliance with
the States.
On the other hand, we persistently meet business
opportunity frauds and that has been the place where more of
our resources have been devoted.
Mr. Rush. Now, I have in my possession this package, the
chairman displayed it also, from the Pizza Hut. This is a
disclosure packet, right?
Mr. Beales. I don't know. I haven't seen it.
Mr. Rush. Yes, my staff inform me that this is a disclosure
package. It is pretty complicated. Very complicated.
Mr. Beales. It is certainly thick.
Mr. Rush. And encompassing. Is there any move by the FTC to
simplify or to require a simplified process? I mean, this is--
you know, you get some family who wants to open a franchise.
They would have to hire a law firm to really look at this stuff
and be able to decipher and understand it. And I know it is a
very complicated financial arrangement that the consumers or
potential business owners are engaging in, but this is
outrageous. You know, this is a thick, a two-inch thick package
of information here, you know, and don't you think that the FTC
has some responsibilities or should assume some responsibility
for trying to simplify this so it will become less burdensome
on the potential business owner?
Mr. Beales. There is always a tradeoff that we meet all the
time in consumer protection regulation between short and sweet,
but necessarily incomplete and comprehensive. Given the amounts
that are particularly at stake in franchise investments, both
the amount of franchise fees and the amount of investment that
is required, what the choice has been is to err if we do on the
side of being complete so that franchisees have the information
they need to make informed decisions.
That said, part of what is at issue in the proposed rule is
at least in some places simplifications to try to make the
information easier for its prospective franchisees to get at--
for example, to try to make more use of graphics and charts, to
present some of the information in a way that is more
straightforward. I would not think it is likely to shorten that
disclosure document very much, but hopefully it makes the
information that is there more comprehensible.
Mr. Rush. Let me ask you this. If you were a potential
franchise owner with Pizza Hut, would you be able to sign this
document without a lawyer?
Mr. Beales. No, I would think I would want to hire a lawyer
to help me in that kind of a relationship, and many
franchisees, many prospective franchisees do.
Mr. Rush. Mr. Chairman, I have just got one other question.
Mr. Stearns. Sure.
Mr. Rush. I am just--it just bothers me that, you know, we
can--the FTC can say that they want to be thorough and they
want to have complete disclosure information available and so
therefore, you know, that this document is, this massive amount
of documents here is appropriate. But on the other hand, the
FTC takes 5 years, you know, to deal, to develop this rule. You
know, it just seems to me that there is a level of
disingenuousness there and I guess you said it wasn't a
priority, but I would assume--I know that in my district, in my
community that there are a lot of franchise owners, a lot of
franchises, people who are employed by franchises. And I just
think that the FTC, to make it--I would advise the FTC to make
this a priority because it just seems like government is not
caring about the problems of consumers and the problems of
business owners, and I would also just suggest strongly that
you all look at trying to simplify this because its just
burdensome, intimidating, and I believe that it opens the door
to all kinds of weird outcomes if in fact we don't get on top
of this and get some control and corral this issue, this
paperwork and this problem.
Thank you, Mr. Chairman. I yield back.
Mr. Stearns. Thank my colleague. Mr. Shimkus.
Mr. Shimkus. Thank you, Mr. Chairman. I want to follow up.
Obviously we are in agreement up here on the panel that if we
are looking at amendments to the 1979 rule there has been no
amendment for 5 years. For us that is very, very unacceptable,
so we need to move expeditiously to do that.
Is it the case that the FTC spends only 6 percent of its
staffs' time on Franchise Rule activities and enforcement when
franchising, according to the GAO audit, represents over half
of all retail sales in the United States?
Mr. Beales. I believe it is either 6 percent or 8 percent
of our staff resources that are devoted to franchise cases.
So----
Mr. Shimkus. But you don't know the percent of the overall
sales in the United States which comes from franchise
operations?
Mr. Beales. No. No.
Mr. Shimkus. But if it is more than 6 to 8 percent,
wouldn't you say--if of course our staff is correct--if they
are saying 50, the argument is there is probably not a direct
proportional share of what efforts are going into this part of
the overall economy versus other operations?
Mr. Beales. Well, I think--I am not sure that looking at
the fraction of sales, of retail sales, is the most useful way
to make that comparison.
Mr. Shimkus. But if it is 50 versus 6, there is a
definite--I would agree with you. I mean, you know, you can use
statistics to prove or disprove anything. But I, again, if the
proportion is so skewed, it would make the argument that there
probably should be more of an effort in a certain area?
Mr. Beales. Well, I guess I would look more at complaints.
Mr. Shimkus. Well, we are going to do that in the next
panel. In fact, I want to follow up with a comment in the
testimony and she will get a chance to testify in a panel, and
I hope we have some members from the FTC that would hang around
and listen, too. Sometimes I wish we would have complainants
first and bureaucrats afterwards because then we could fully
air it.
Ms. Kezios recommends that the U.S. Department of Commerce
collect comprehensive and accurate statistical information
about franchising and franchise practices by, one, requiring a
national filing of disclosure documents and, two, data
collection and analysis.
Do you agree with this recommendation and why or why not?
Mr. Beales. I have not thought through that recommendation
or explored it in any detail. I think--I mean, as a former
academic and actually as a former academic who studies
franchising, more information is always attractive. But there
are burdens on the people who have to produce that information
as well. We haven't seen a need for pre-filing or pre-approval
of the disclosure documents in the franchise complaints or the
franchise issues that we have seen.
Mr. Shimkus. And previous to this last response you talked
about a better barometer is complaints. And you have already
admitted that the Commission received 3,680 complaints
regarding franchises in just the period between 1993 and 1999.
And you state that since 1979 the Commission has pursued 200
franchise and business opportunity cases. This number, given
the number of complaints, seems low. Why haven't we seen more
enforcement action?
Mr. Beales. Well,the complaints--it is a sizable number of
complaints. It is about 2 percent of the total number of
complaints that we get. So in terms of where our resources are
allocated, franchising and business opportunities get a
disproportionate share based on the number of complaints. The
reason for that is the consumer injury in these kinds of cases
tends to be quite high compared to what we see in a lot of
other cases. We think there is--you know, we have tried very
hard to leverage our resources in this area with both our
Federal law enforcement through the Department of Justice and
through State enforcement activities as well that gives us a
lot more clout than that, than the 200 cases we have brought.
In this sweep last week, for example, we brought 11 cases. The
Justice Department brought 11 cases and there were more than 48
cases brought by--or 48 actions, enforcement actions, brought
by the State. So those 70 cases would show up in that statistic
as 11 FTC cases.
Mr. Shimkus. Mr. Chairman, if I could just finish up with
this question.
Mr. Stearns. Sure.
Mr. Shimkus. Does the fact that franchisors often prohibit
franchisees from discussing their franchise experience with
anyone after they leave the system undermine the Franchise
Rule?
Mr. Beales. Well, I think the thing that would be a problem
for the--or a potential problem for the rule is if there is
nobody you can talk to to find out about what their experience
was like and you didn't know that.
Mr. Shimkus. The acronym ``let the buyer beware,'' but the
buyer ought to be able to do research prior to going into an
agreement. I mean, when you buy a house you can go around and
check fair market values of like homes. You can actually talk
to contractors and people. There are things that you can do.
But if there is a prohibition about discussions then that would
seem to undermine some of the ability to go into an agreement.
Mr. Beales. Well, one of the things that is in the proposed
changes would be----
Mr. Shimkus. These are the amendments to the 1979 rule; is
that the changes you are talking about?
Mr. Beales. Yes.
Mr. Shimkus. And will we be looking at these any time soon
or do we still have 5 years before we receive amendments? I
mean, it is so ridiculous to keep saying that, to tell you the
truth. The proposed amendments which are 5 years old and we are
proposing these to occur, can you see our frustration?
Mr. Beales. I can. I can.
Mr. Shimkus. So I think it probably would be incumbent upon
the chairman and the committee to probably tie you down and say
when will we see these. I will defer that to the chairman and,
Mr. Chairman, I yield back my time.
Mr. Stearns. That is a good question. You can ask it.
Mr. Shimkus. No, go ahead.
Mr. Stearns. When will we see these?
Mr. Beales. We are planning to forward the staff report in
the fall. The staff report goes out for public comment and then
after another comment period on the staff report a final
recommendation would be forwarded to the Commission. I haven't
tried to figure out the time line beyond the staff report,
which is sort of the next step in the process. Typically the
comment period would be like 60 days and then analysis of the
comments.
Mr. Stearns. Okay. So maybe October you will have the staff
report and then 60 days thereafter?
Mr. Beales. Well, the staff report--yeah, it may be
somewhat longer than that for the Commission to consider the
staff report, although I think in the rulemaking process that
is limited. Most of that consideration is after the comment
period, not before.
Mr. Stearns. And after the 60 days what is going to happen?
Mr. Beales. We will analyze the comments.
Mr. Stearns. How long will that take?
Mr. Beales. It depends in part on how many comments we get
and how substantive the comments are.
Mr. Stearns. What is the general time?
Mr. Beales. Well, it varies from, I mean I have seen--well,
in Magnus and Moss----
Mr. Stearns. Less than 6 months?
Mr. Beales. It certainly can be less than 6 months.
Mr. Stearns. Okay. So in the next year and a half we should
see the file?
Mr. Beales. We would be hopeful that we could meet that
timetable.
Mr. Stearns. Okay. Mr. Walden.
Mr. Walden. Actually, Mr. Chairman, I have no questions at
this time.
Mr. Stearns. Okay, thank you. Thank you very much, Mr.
Beales. I appreciate your coming again.
Mr. Beales. Thank you for the opportunity.
Mr. Stearns. And we will have the second panel now if they
will come forward. Mr. Dale Cantone, Assistant Attorney General
of the Maryland Securities Division; Mr. Les Wharton, Vice
President, Legal Affairs, Franchise/License Division, Spherion;
Ms. Susan Kezios, President of the American Franchisee
Association; Mr. Dennis Wieczorek, Partner, at Piper Rudick,
and he is here on behalf of the International Franchise
Association; and last, Mr. Jerry Rizer, who is President of
Dairy Queen Operators' Association.
Let me thank all of you for attending this morning and we
look forward to your testimony, and why don't we start from my
right and go to my left. Mr. Cantone for your opening
statement.
STATEMENTS OF DALE E. CANTONE, ASSISTANT ATTORNEY GENERAL,
MARYLAND SECURITIES DIVISION; PHILLIP LESLIE WHARTON, VICE
PRESIDENT, LEGAL AFFAIRS, FRANCHISE/LICENSE DIVISION, SPHERION;
SUSAN P. KEZIOS, PRESIDENT, AMERICAN FRANCHISE ASSOCIATION;
DENNIS E. WIECZOREK, PARTNER, PIPER RUDNICK, ON BEHALF OF THE
INTERNATIONAL FRANCHISE ASSOCIATION; AND JERRY RIZER,
PRESIDENT, DAIRY QUEEN OPERATORS' ASSOCIATION
Mr. Cantone. Thank you, Chairman Stearns and member of the
subcommittee. My name is Dale Cantone. I am the Deputy
Securities Commissioner in the Office of the Maryland Attorney
General. I also chair the Franchise and Business Opportunity
Project Group of the North American Securities Administrators
Association, known as NASAA, and on behalf of NASAA I
appreciate the opportunity to appear before you today.
As franchising continues to be an important and evolving
business strategy in today's economy, the laws dealing with
franchising also must evolve to protect consumers who invest in
a franchise. Current Federal and State franchise laws require,
among other things pre-sale disclosure. This requirement is
intended to provide each prospective franchisee with all of the
information necessary to make an intelligent investment
decision before the franchisee pays any money.
As has been recognized at the State level, 15 States have
enacted laws regarding franchise offerings. These States
require franchisors to prepare disclosure documents according
to Uniform Franchise Offering Circular guidelines, called the
UFOC. Since 1994, the FTC has accepted the UFOC as an
alternative to the disclosure documents required under its own
Franchise Rule. Although the UFOC is required in only 15
States, for practical reasons many franchisors prefer the UFOC
format. This is because the UFOC is generally considered to be
a better disclosure document than the one required under the
FTC's Franchise Rule and because many franchisors intend to
sell franchises in at least one of the registration States. But
the UFOC is not required to be used in the States without a
separate State franchise law.
Now, 23 years after the promulgation of the Franchise Rule,
it is time for the FTC to update its disclosure document, the
document that is required in all 50 States, and the logical
model for the FTC to follow is the UFOC. The UFOC is more user
friendly to prospective franchisees. It requires that
disclosures be written in plain English. It also requires
disclosure of items that are relevant in today's business
climate; for example, issues related to computers, protected
territory or the lack of one and use of advertising moneys.
The Federal Trade Commission has recognized this fact and
is currently considering a proposal to model its own Franchise
Rule disclosure on the UFOC with some additional enhancements.
NASAA supports this proposal. The adoption of a disclosure
format based on the UFOC would be a significant improvement to
the Franchise Rule.
What is still missing at the Federal level, however, is a
private right of action under the Franchise Rule. Without a
private remedy injured franchisees must rely on the already
strained resources of governmental agencies for redress. When
those agencies are unable to take action for whatever reason,
franchisees are unable to sue to recover losses due to
franchise law violations. As the FTC continues its work on the
Franchise Rule review, NASAA remains ready to offer any
assistance that will help to ensure the prospective franchisees
receive the most readable and material disclosure possible.
The other issue I wish to address today relates to a type
of investment opportunity called a business opportunity.
Business opportunity ventures are regulated under the FTC's
Franchise Rule, but they are clearly distinguishable from a
franchise. Business opportunity sellers provide little, if any,
assistance and training and exert little control over business
opportunity buyers. The buyers generally do not operate under
the sellers' trademark or trade name. Typical examples of
business opportunities include vending machines, medical
billing software programs, greeting card display racks.
As has been recognized in the last few years, the Federal
Trade Commission has focused its enforcement activities on
business opportunities. The FTC reports more complaints about
business opportunities than franchises and complaints about
business opportunities generally involved allegations of fraud
or misrepresentation.
Just last week the Federal Trade Commission, the Department
of Justice, and 17 States announced Project Busted Opportunity,
a coordinated attack on business opportunity and work at home
fraud. The sweep is just the latest in a series of Federal-
State initiatives regarding business opportunities. There is no
doubt that communication and coordination between Federal and
State officials on business opportunity issues is critical. In
many cases, business opportunity con artists maintain offices
in one State, but avoid selling to consumers in that State in
an effort to avoid prosecution and detection by State
officials.
The FTC regularly does seek to communicate with State
enforcement personnel in this area, through conference calls
and e-mail, List Serve and an on-line complaint data base
called Consumer Sentinel. For the last several years the FTC
also has sponsored annual law enforcement summits on franchises
and business opportunities. The summit wasn't held this year,
but we do hope the FTC reconsiders reestablishing the summits
in the future.
NASAA and State business opportunity enforcement officials
look forward to continued opportunities to coordinate with the
FTC on enforcement actions and consumer education on both
franchises and business opportunities. By working together we
can be more effective in these very important areas.
Mr. Chairman and members of the subcommittee, thank you for
allowing NASAA to participate in this hearing.
[The prepared statement of Dale E. Cantone follows:]
Prepared Statement of Dale E. Cantone, Deputy Securities Commissioner,
Chief, Franchise and Business Opportunities Unit, Office of the
Maryland Attorney General, Securities Division, on Behalf of the North
American Securities Administrators Association
Mr. Chairman and Members of the Subcommittee: My name is Dale
Cantone. I am the Deputy Securities Commissioner in the Office of the
Maryland Attorney General. I also chair the Franchise and Business
Opportunity Project Group of the North American Securities
Administrators Association (``NASAA''). In the United States, NASAA is
the national voice of the 50 state securities agencies responsible for
investor protection and the efficient functioning of the capital
markets at the grassroots level. Many of the agencies that administer
and enforce state franchise and business opportunity laws are members
of NASAA.
On behalf of NASAA, I appreciate the opportunity to appear before
you today. Franchising continues to be a vibrant and popular business
strategy in our economy. Oversight of franchising is an important
consumer protection for hundreds of thousands of existing and
prospective franchisees. It requires careful attention by both federal
and state authorities. NASAA welcomes the subcommittee's interest in
this issue and looks forward to working with you and your staffs. My
comments today will focus on two issues: state and federal franchise
disclosure requirements; and state and federal cooperation on business
opportunity enforcement initiatives.
franchise regulation: an overview
Oversight of franchising at the state level is grounded in the
traditional commitment of grassroots officials to protect consumers
whenever possible before they part with their money; and in those cases
where money is lost in a fraudulent deal, to marshal the enforcement
resources to shut down the violator and seek restitution if possible.
California adopted the first state franchise statute in 1971.
Today, 15 states 1 have statutes that regulate the offering
of franchises for sale. Eleven of these states 2 operate
under similar or uniform statutes that require registration with a
state agency and delivery of disclosure documents to prospective
franchisees prior to an offer and sale of a franchise.
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\1\ California, Hawaii, Illinois, Indiana, Maryland, Michigan,
Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota,
Virginia, Washington and Wisconsin.
\2\ California, Hawaii, Illinois, Maryland, Minnesota, New York,
North Dakota, Rhode Island, South Dakota, Virginia and Washington. In
addition, Oregon requires disclosure prior to the sale of franchises,
but does not have a registration or filing process. Indiana, Michigan,
and Wisconsin require disclosure and the filing of a ``notice of
franchise offering.''
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Both state and federal franchise disclosure laws are intended to
provide each prospective franchisee with the information necessary to
make an intelligent decision regarding the franchise being offered.
Further, state franchise laws bar the sale of franchises where such
sales would lead to fraud or a likelihood that the franchisor's
promises would not be fulfilled.
At the federal level, the Federal Trade Commission (``FTC'')
adopted its Franchise Rule 3 in 1979. While the FTC's
Franchise Rule requires presale disclosure, there is no federal
requirement that a franchisor register its disclosure document with the
Commission, and no one at the federal level reviews the disclosure
documents that a franchisor must provide to prospective franchisees.
The Franchise Rule expressly preserves the right of states to adopt
laws that are not inconsistent with the Franchise Rule if those laws
provide protections that are equal to or greater than that provided by
the Rule.
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\3\ Trade Rule 436, ``Disclosure Requirements and Prohibitions
Concerning Franchising and Business Opportunities Ventures'' (16 CFR,
Ch.1, Part 436).
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The franchise registration laws that 15 states have adopted are
designed to provide greater protections to prospective franchisees and
prevent fraud in the sale of franchise offerings. Eleven states require
that franchise disclosure documents be filed and reviewed by trained
state personnel, called franchise examiners. Through their efforts,
state examiners can better discover proposals that are fraudulent or
unlawful, and thereby protect state consumers before they have parted
with their money.
Although all states do not require registration of franchise
offerings, few franchisors sell in non-registration states only. Thus,
franchise reviews conducted by so-called ``registration states'' have
improved the standard of disclosure generally in the franchise market.
In recent years, some have questioned the need for any state to
perform reviews of offering circulars. Yet the registration and review
function is an important part of the franchise regulatory scheme.
Although large franchisors typically retain experienced lawyers to
draft franchise disclosure documents, even large franchisors sometimes
fail to disclose all of the information required by the disclosure
guidelines. In addition, some large franchisors target unsophisticated
franchisees. The franchise review process can better inform the
unsophisticated franchisee about risks the franchisee may not fully
appreciate. The states' ability to require financially undercapitalized
franchisors to escrow franchise fees also benefits prospective
franchisees. State examiners may identify specific ``risk factors''
that a franchisor must disclose on the cover of state disclosure
documents. These risk factors highlight special concerns that a
franchisee should consider before investing in a franchise.
In addition, not all franchisors are well established or
experienced in preparing offering circulars. States routinely receive
franchise registration applications from start-up and smaller franchise
systems. Some of these applications are prepared without benefit of
legal counsel. Some do not even begin to approach substantial
compliance with the state guidelines. For these franchisors and, more
important, for their prospective franchisees, the review function
conveys a critical benefit.
State agencies that require filing of franchise disclosure
documents also serve as an important repository of information for
prospective franchisees to compare documents from various franchisors.
In many instances, this information is crucial to the process
undertaken by investors to evaluate franchise deals. Many franchisors
do not deliver copies of their disclosure documents to the public upon
request.
The states have a broad assortment of enforcement tools available
under their franchise laws that allow them to move swiftly and
decisively against violators. States may issue orders prohibiting
violations of the law, as well as orders denying, suspending and
revoking registration and exemption of franchises. In addition, states
have injunctive and criminal referral authority.
Franchisees in registration states benefit tremendously from the
private right of action granted under state law. In contrast, private
parties cannot enforce violations of the FTC Rule; only the FTC has
that authority. A private right of action allows consumers to sue for
damages when they sustain losses due to franchise law violations. The
experience of state regulators is that private remedies serve as a
necessary supplement to governmental regulation and enforcement efforts
in providing a deterrence to abuse. Without private remedies, injured
franchisees can be protected only through governmental action. The
absence of a private remedy places a greater premium and demand on the
already strained resources of the regulatory agencies and frequently
means that fewer injured franchisees can be ``made whole'' than would
be the case if a private right of action was explicitly authorized in
the law.
the role of nasaa
An important goal of NASAA is the promotion of efficient and
uniform state laws. In the franchise regulation area, it is NASAA's
intention to move forward and continue the serious efforts the
Association has undertaken to promote uniformity of state law, provide
enhanced training and educational opportunities for state franchise
personnel, seek ever more cooperative relationships with the Federal
Trade Commission, and solicit the advice and input of franchisors and
franchisees.
To further the goal of state uniformity, NASAA authored and
encouraged adoption of the UFOC Guidelines. NASAA sponsors regular
franchise training programs and educational seminars for state
franchise examiners. NASAA also regularly proposes uniform statements
of policy on many franchise related issues. These statements of policy
are model laws and regulations that are made available for states to
adopt in accordance with their laws. NASAA recently implemented a new
Internet ``List Serve'' by which state examiners and enforcement
personnel can contact each other to discuss issues of common concern
and seek effective solutions to matters involving franchise reviews and
potential enforcement actions.
Two years ago, NASAA developed and launched a new program of
coordinated franchise review, which has been adopted by all of the
franchise registration states except California. Coordinated franchise
is a voluntary program open to franchisors that allows them to file a
franchise registration in multiple states at the same time. Coordinated
review eliminates conflicting comments by state examiners and results
in a single, uniform franchise offering circular that is made effective
on the same date in multiple jurisdictions.
the uniform franchise offering circular guidelines
NASAA authored the Uniform Franchise Offering Circular (``UFOC'')
Guidelines after holding public hearings and extensive discussion with
members of the franchisor and franchisee communities, academics, and
the FTC. On April 25, 1993, NASAA unanimously adopted the UFOC
Guidelines as the recommended format for franchise disclosure documents
at the state level. Within two years, the new Guidelines were adopted
by each of the state franchise regulatory authorities that require
registration of franchise offerings. On December 30, 1993, the FTC
approved the use of the UFOC as an alternative to the FTC's disclosure
requirements.
As part of its ongoing Rule Review, the FTC is currently
considering a proposal to replace the franchise disclosure requirements
4 under the Franchise Rule with updated disclosure
requirements based in large part on the UFOC Guidelines, with some
additional disclosures. NASAA supports the FTC's efforts to modify the
Franchise Rule in this way.
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\4\ Described at 16 CFR Sec. 436 (a) (1) through (20).
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The UFOC is the only franchise disclosure document that franchisors
may use in the 15 states that register franchise offerings. The UFOC
Guidelines are, in fact, a revision of several earlier versions of the
Guidelines, versions of which have been in effect since 1975. The UFOC
Guidelines reflect an effort on the part of NASAA to produce a more
readable and relevant disclosure document for franchisees, and one that
does not unduly burden franchisors. It is a disclosure document that
was based on the experiences of many individuals in the franchise
community as to what constitutes ``material'' information about a
franchise offering.
NASAA asserts that the UFOC is a superior disclosure document than
the current disclosure document required under the Franchise Rule. The
UFOC requires disclosure of information that franchisees need to know
in order to make an informed investment decision in the present
business environment. For example, the UFOC requires disclosure of
required computer hardware and software (UFOC Guidelines, Item 8 A),
including whether the franchisor will have independent access to the
stored data (UFOC Guidelines, UFOC Guidelines, Item 11, Instruction 11
iii c). The UFOC Guidelines require extensive disclosure about a
franchisor's use of advertising dollars and advertising programs (UFOC
Item 11). There is extensive disclosure about protected territory, or
the lack of one, and the franchisor's ability to establish alternative
channels of distribution in a protected territory (UFOC Item 12). The
UFOC is intended to be written in ``plain English'' (UFOC Instruction
150) and features a readable cover page that emphasizes the most
important aspects of the disclosures in the document.
There would be a significant advantage to franchisors if the FTC
were to adopt a new Franchise Rule based on the UFOC model. Many
franchisors, especially those that offer franchises in multiple
jurisdictions, have experience with preparing an offering circular
based on the UFOC Guidelines. The Guidelines are intended to produce a
single disclosure document that may be used in multiple states. In
addition, many of the questions of interpretation that inevitably
accompany any new guideline or regulation have been answered. The UFOC
Guidelines have been the subject of numerous programs and seminars open
to franchisors and franchisees. In 1994 and 1998, NASAA published
Commentaries to the UFOC designed to discuss and clarify issues of
interpretation.
As part of the FTC's recent Franchise Rule Review, the FTC has
sought input from NASAA and a variety of other sources representing
both franchisors and franchisees. In addition, the FTC has sought to
work with NASAA and the franchise review states to ensure that the new
disclosure document to be required under the Franchise Rule provides
enhanced and commonsense disclosures for franchisees. As a result, the
FTC has identified several disclosure items not currently required
under the UFOC Guidelines that the FTC may seek to require under the
revised Franchise Rule, for example, new disclosures related to a
franchisor's parent and franchisor initiated litigation.
The disclosure document that the FTC has proposed under its Rule
Review is a significant improvement over the existing format. Adoption
of a federal franchise disclosure document consistent with the current
proposal would benefit prospective franchisees in every state,
especially those who reside in the 35 states that do not currently
require a disclosure document to be prepared under the UFOC Guidelines.
NASAA and the franchise review states look forward to continuing to
work with the FTC as it seeks to finalize the new Franchise Rule.
distinguishing between disclosures for business opportunities and for
franchises
One of the other proposals in the FTC's Franchise Rule Review is to
include a specific definition of ``business opportunity'' that
distinguishes it from a ``franchise.'' NASAA applauds this effort. This
distinction is necessary in order to avoid the current confusion caused
by the FTC's attempts to regulate two distinct types of business
enterprises under one rule. Typical ``business opportunities'' include
distributorships involving vending machine, greeting card display
racks, and medical billing software.
Currently, 24 states regulate the offer and sale of ``business
opportunities.'' Many states require registration of business
opportunity sellers as well as presale disclosure to prospective
buyers. In general, states require business opportunity sellers to
provide a disclosure document that, in most cases, is simpler and more
abbreviated than the type of disclosure document required for franchise
offerings.
Most business opportunity ventures are clearly distinguishable from
a franchise. Business opportunities generally require much smaller
investments than the fees required to purchase a franchise and unlike
franchisors, business opportunity sellers provide very little, if any,
assistance and training and exert little control over business
opportunity purchasers. The contracts are simpler and impose fewer
restrictions on buyers. In addition, business opportunity buyers
generally do not operate under the sellers' tradename, trademark, or
service mark. The creation of a separate definition of a business
opportunity under the Franchise Rule would recognize these differences.
A separate definition for business opportunities also would improve
state and federal enforcement efforts. Prospective business opportunity
buyers have expressed their concern and confusion over the type of
investment being purchased. For example, a business opportunity under
state law might be considered a franchise under the Franchise Rule.
Adopting a clear and distinct definition of a business opportunity
would enable prospective buyers to determine what rules apply--to their
investments. This revision also would benefit state and federal
enforcement efforts by clearly defining the type of investment
opportunity being investigated.
federal and state cooperation on business opportunity enforcement
actions
On June 20, 2002, the FTC, Department of Justice (``DOJ'') and 17
states announced ``Project Busted Opportunity,'' a coordinated attack
on business opportunity and workathome fraud. The initiative included a
consumer education campaign and a law enforcement sting targeting
hucksters who use deceptive earnings claims and paid ``shills'' to
promote their scams or otherwise violate consumer protection laws.
Seventyseven operations were caught in the sting.
The 17 state law enforcement agencies participating in Project
Busted Opportunity announced a total of 48 actions against business
opportunity sellers. Those actions include lawsuits, cease and desist
orders, consent agreements, and fines. The FTC and DOJ each brought 11
cases in federal court.
Project Busted Opportunity is but the latest in a series of
federal/state enforcement sweeps regarding business opportunity fraud.
Since 1995, the FTC has organized at least six federal/state
coordinated sweeps aimed primarily at business
opportunities.5
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\5\ See United States General Accounting Office, Federal Trade
Commission Enforcement of the Franchise Rule: Report to Congressional
Requesters; Table 7, p. 66 (July 2001).
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From about 1995 until 2001, the FTC and NASAA have jointly
sponsored annual law enforcement summits dealing with business
opportunities, franchises and pyramid schemes. These summits presented
an opportunity for state and federal law enforcement officials to
communicate with each other and coordinate law enforcement issues. At
the summits, state and federal law enforcement personnel had the
opportunity to meet and discuss current and anticipated enforcement
actions, upcoming sweeps, industry trends, investigative techniques,
and consumer education. Last year, the FTC did not hold an annual law
enforcement summit on franchises or business opportunities. NASAA hopes
that, in the future, the FTC will join us again in co-sponsoring these
important events.
FTC staff also regularly communicates with state enforcement
personnel through regular conference calls, an FTC sponsored business
opportunity List Serve, and Consumer Sentinel. Consumer Sentinel is an
on-line complaint database repository available to approximately 250
law enforcement agencies around the U.S., Canada and beyond. The
Consumer Sentinel database is a valuable resource, and has proven
itself to be an especially effective tool in the fight against business
opportunity fraud.
There is no doubt that communication between federal and state
officials on business opportunity issues is critical. In many cases,
business opportunity con artists maintain their offices in one state
but avoid selling to consumers in that state, in an effort to avoid
detection and prosecution by state law enforcement officials. In those
instances, it is critical for states to work with each other and
federal officials to make sure that the business opportunity con
artists are identified, caught and brought to justice.
NASAA and state business opportunity enforcement officials look
forward to continued opportunities to work with the FTC and each other
to take effective action against con artists who commit business
opportunity fraud. We hope to continue and expand interagency
opportunities to work together on both enforcement matters and consumer
education.
conclusion
Mr. Chairman and members of the Subcommittee, NASAA appreciates
your interest in franchising and the role of the states in safeguarding
the interests of franchisees. It should be apparent that the current
system of state franchise regulation is a vital component of the entire
regulatory scheme in this area. Clearly, oversight of franchise and
business opportunity offerings is an important consumer protection for
the hundreds of thousands of people who invest in these operations. We
look forward to a continuation of federal and state cooperation on
franchising and business opportunity issues.
Thank you.
Mr. Stearns. Thank you. Mr. Wharton.
STATEMENT OF PHILLIP LESLIE WHARTON
Mr. Wharton. Good morning, Mr. Chairman, members of the
subcommittee. Thank you for inviting me today to discuss the
FTC Franchise Rule. My name is Les Wharton. I am the Vice
President of Legal Affairs for the Franchise/License Division
of Spherion Corporation.
Spherion is a staffing company founded in 1946. We are
headquartered in Fort Lauderdale, Florida, and operate a
network of approximately 940 locations primarily in North
America. Our stock is publicly traded on the New York Stock
Exchange. We were created in the merger of two large staffing
companies in 1999, Norrel and Interim Services. Spherion has
been franchising since 1956. I chair the International
Franchise Association's Corporate Counsel Committee, and I am
also the vice chair of the Legal Legislative Committee of that
organization. I have been involved in franchising since 1981.
I believe that the Federal and State pre-sale disclosure
process is critically important in providing a framework within
which small business franchise investors can evaluate franchise
investment opportunities. At Spherion we want our franchisees
to be fully aware of how our business operates before they
become franchisees. We also want our franchisees to understand
how a franchise relationship is structured and what our
respective obligations are during the course of the
relationship.
Preparation of a disclosure document takes substantial time
and effort and is expensive. But pre-sale disclosure, the pre-
sale disclosure process is good for franchise investors and for
franchise systems. It provides the basis for both parties to
consider whether they want to do business with each other.
We want our franchisees to make a commitment to our brand
and our way of doing business, and the only way that they can
do that is if they are fully informed about what we do and the
way that we do it. We don't want any surprises about what is
expected of us after the relationship begins, and neither do
our franchisees.
It is not in our short-term or long-term interest to expand
our business with franchisees unless they are fully aware of
our operating standards and business philosophy, and it is not
in their short-term or long-term interest to make an investment
with us unless they understand and embrace our business
concept. The pre-sale disclosure process protects both
franchisees and franchisors and creates a business climate in
which franchising has flourished.
I am very encouraged about the FTC current effort to revise
and modernize its Franchise Rule. There are a number of
proposed revisions that will be particularly important, but I
would like to take a moment to discuss four of the proposed
revisions.
First, we believe that the proposal to replace the current
FTC rule format with the Uniform Franchise Offering Circular
format, developed by State franchise regulators, is a very
positive step. This will eliminate inconsistency between
disclosure documents provided to franchise investors.
Second, I believe it is important that the FTC develop
separate disclosure rules for franchises and business
opportunities. Franchise investments are so distinct from
business opportunities that each should have and must have its
own rule.
Third, I agree with the FTC's recommendation not to require
a mandatory earnings claim. A uniform, ``one size fits all''
approach to disclosing earnings information will not work. Our
business operations are significantly different from the
operations of other franchised businesses in other industries.
It makes no sense to require all franchised businesses,
regardless of the industry in which they operate, to provide
earnings information on a uniform basis. I believe that the
best way for the franchise investor to evaluate the potential
from a franchise business is, one, to thoroughly review the
franchise disclosure document; two, to get professional legal
and financial assistance in that review; and, most importantly,
to talk with as many current and former franchisees as possible
before making that development. It is important to note here
that a list of the names and addresses and phone numbers of the
current franchisees as well as those who have left the system
within the last year is required by the rule to be part of the
disclosure document.
Fourth, I support the FTC's efforts to modernize the rule
in order to permit an electronic disclosure. At the time it was
promulgated we didn't even have fax machines. Now we have e-
mail Web sites. It has significantly altered the way that we do
business.
I believe that the FTC has created a thorough and
comprehensive record on which to move forward in its
rulemaking, and I believe that as a result the forthcoming
revisions to the rule will receive wide support from interested
parties.
In closing, let me reiterate my support for the pre-sale
disclosure process and emphasize the great benefits of pre-sale
disclosure for both the franchisees and the franchisors.
Franchising is founded on open and honest relationships, and on
realistic expectations about the franchise business. There is
no better way to ensure a mutually successful franchise
business enterprise than for both parties to enter into the
business fully aware of what their mutual rights and
obligations are.
Thank you.
[The prepared statement of Phillip Leslie Wharton follows:]
Prepared Statement of Phillip Leslie Wharton, Vice President, Legal
Affairs, Franchise/License Division, Spherion Corporation
Good morning.
Mr. Chairman and members of the Subcommittee thank you for inviting
me to appear today to discuss ``The FTC Franchise Rule: Twenty-Three
Years After Its Promulgation.''
My name is Les Wharton. I am the Vice President, Legal Affairs, for
the Franchise/License Division of--Spherion Corporation (``Spherion'').
Spherion is a staffing company that delivers performance-enhancing
solutions to businesses in recruitment, technology and outsourcing
services. Founded in 1946, Spherion is headquartered in Ft. Lauderdale,
Florida and operates a network of approximately 940 locations primarily
in North America, and includes operations in Europe and Australia/Asia.
Its stock is publicly traded on the New York Stock Exchange. Spherion's
revenues last year were $2.7 billion.
Spherion operates its clerical and light industrial staffing
business through 372 company owned and 246 franchised locations. It has
been franchising that business since 1956.
I am also Chairman of the International Franchise Association's
Corporate Counsel Committee, a committee of approximately 60 in-house
franchise counsel, and Vice-Chair of the Legal/Legislative committee of
the International Franchise Association. I have been involved in
franchising since 1981. I am a member of the American Bar Association
(the ``ABA'') Forum on Franchising and I have served for some time as a
member of the Steering Committee of the Forum's Corporate Counsel
Division. I am also a member of the Franchise Committee of the
International Bar Association. I have been a speaker on franchise
topics at IFA meetings and Legal Symposia, and at the ABA Annual
Meeting as well as at the Forum on Franchising Annual Meeting.
It is a pleasure to be here to discuss this important topic. I
believe that the federal and state pre-sale disclosure process is
critically important in providing a framework within which small
business franchise investors can evaluate franchise investment
opportunities. At Spherion, we want our franchisees to be fully aware
of how our business operates before they become franchisees. We also
want our franchisees to understand how our franchise relationship is
structured and what our respective obligations are during the course of
the relationship.
The presale disclosure process is good for franchise investors and
for franchise systems, because it provides the basis for both parties
to consider whether they want to do business with the other. We want
our franchisees to make a commitment to our brand and our way of doing
business, and the only way they can do that is if they are fully
informed about what we do and why we do it. We don't want any surprises
about what is expected of us after the relationship begins, and neither
do our franchisees.
It is not in our short or long term interest to expand our business
with franchisees unless they are fully aware of our operating standards
and business philosophy. And it's not in their short or long term
interest to make an investment with us unless they understand, and
embrace, our business concept. The presale disclosure process protects
both franchisees and franchisors, and creates a business climate in
which franchising has flourished.
I am very encouraged about the FTC's current effort to revise and
modernize its Franchise Rule. There are a number of proposed revisions
to the Rule that will be particularly beneficial to Spherion. I would
like to take a moment to mention several of those proposed revisions.
First, we believe that the proposal to replace the current FTC Rule
format with the Uniform Franchise Offering Circular format developed by
state franchise regulators is a very positive step. The UFOC was
updated several years ago, and unlike the FTC Rule is accepted in all
states that have adopted state franchise laws. For a company like
Spherion, with operations all across the U.S., the harmonization of the
federal and state disclosure formats will be a significant improvement.
This will eliminate any inconsistency between disclosure documents
provided to franchise investors and create greater consistency for
anyone considering a franchise investment.
Second, I believe that it is important that the FTC develop
separate disclosure rules for franchises and business opportunities.
Franchise investments are sufficiently distinct from business
opportunities that each should have its own rule. In addition, because
the vast majority of complaints alleging violations of the FTC Rule
involve business opportunities and not franchises, separate rules would
result in greater accuracy in categorizing complaints and obtaining
relief for investors.
Third, I agree with the FTC's recommendation not to require
mandatory earnings claims. A uniform, one-size-fits-all approach to
disclosing earnings information will not work. Spherion's business
operations are significantly different from the operations of other
franchised businesses in other industries. It makes no sense to require
all franchised businesses, regardless of the industry in which they
operate, to provide earnings information on a uniform basis.
Further, since we do not maintain the books of our franchisees, it
would be virtually impossible for us to ascertain the validity of any
cost information that they provided us to use in making such earnings
claims. As a result, franchise investors would receive information that
we could not verify and which could be less than accurate.
I believe that the best way for a franchise investor to evaluate
the potential earnings from a franchised business is to obtain and
thoroughly review the franchise disclosure document, retain
professional legal and financial assistance in that review and most
importantly, to talk to as many current and former franchisees as
possible before making the investment. A list of our franchisees,
including addresses and telephone numbers, is included in the
disclosure document.
Finally, I would like to indicate support for the FTC's efforts to
modernize the Rule in order to permit electronic disclosure. At the
time the FTC Rule was promulgated, we didn't even have fax machines.
Now we have email and websites that have significantly altered the way
in which we do business. I believe that the FTC's efforts in this area
are critical, as electronic communication has the potential to provide
greater, more readily available information to franchise investors
while simultaneously reducing costs both to franchisors and
franchisees.
There are other proposed changes to the FTC Rule in which I have an
interest, but I wanted to highlight these four because of their
importance to Spherion as well as the rest of the franchise community.
I believe that the FTC has created a thorough and comprehensive record
on which to move forward with its rulemaking, and believe that as a
result the forthcoming revisions to the Rule will receive wide support
from all interested parties.
In closing, let me reiterate my support for the presale disclosure
process and emphasize the great benefits of presale disclosure for both
franchisees and franchisors. Franchising is founded on open and honest
relationships, and on realistic expectations about the franchised
business. There is no better way to ensure a mutually successful
franchise enterprise than for both parties to enter into the business
fully aware of their mutual rights and obligations to make the business
a success.
Thank you again for taking the time to discuss this important
subject, and for inviting me here to appear today.
Good morning.
Mr. Stearns. I thank the gentleman.
Ms. Kezios.
STATEMENT OF SUSAN P. KEZIOS
Ms. Kezios. Mr. Chairman, my name is Susan Kezios,
president of the American Franchisee Association. The
Franchisee Association is made up of the small businesspeople
who buy the franchises from the corporate franchisors like Mr.
Wharton's company.
We are here because 23 years after the promulgation of the
FTC rule, my franchisees, my members have big problems. They
have got big problems postsale because of what happens and what
doesn't happen in the presale process. We estimate that our
members, 15,000 of our AFA members in the aggregate, we have
about $7.5 billion in sunk costs in their businesses.
So these are the men and women, the families who buy the
franchises, who invest their money, and who work the
businesses. Like everybody else here, we are all for full and
complete disclosure; however, under the current scheme, I am
here to tell you that that is an impossibility.
There is some important background that you should know.
The FTC's Franchise Rule was promulgated in 1979 based on
1960's market conditions. So it was designed to address the
dysfunctions of what was going on in franchising in the 1960's,
and in the 1960's the scam in franchising was in the presale
process. The scam in franchising today is not in the presale,
it is in the contract.
During those days, the 1960's into the 1970's, when the
FTC's rule was being debated, certain corporate franchisor
lawyers worked to hobble the promulgation of the rule. When the
rule's promulgation was inevitable, they worked then to weaken
its effectiveness. That is where we are today. We have a weak
rule with even weaker enforcement.
Our members have little faith in the FTC. They have little
faith in the FTC's enforcement of the rule for three reasons.
One, as has already been mentioned by a member of this
subcommittee, the disclosure documents are written to
circumvent the existing rule. Any franchisor--corporate
franchisor lawyer worth his or her salt can write a disclosure
document that will meet the minimum requirements of the FTC's
rule.
Second, the franchise contracts that the franchisees sign
actually deprive small business owners of many basic legal
rights, common law rights. Someone surmised earlier that I am
sure we can go and bring a private right of action. No. In
fact, in many contracts you waive your right to a jury trial in
order to become a franchise owner of XYZ Company.
And No. 3, corporate franchisor lawyers write the contacts
in such a way that the contracts can change after you sign.
They become a moving target, and for somebody whose investment
is sunk into the business, they can't move anywhere, they have
to deal with that contract afterwards.
When our members enter into franchise contracts and into
the franchise business relationship, they do so with the intent
of dealing with their franchisor in good faith. Franchisors
today are even teaching each other--the corporate franchisor
lawyers are teaching each other how to draft contracts to
negate the duty of good faith. That is something that I will
submit to the committee that came to our attention recently.
So you need a fleet of attorneys to begin with to
understand that 2-inch-thick disclosure document. And as Mr.
Rush pointed out, how many families are going to invest in the
time and invest in the lawyers to do that?
Now, in my written statement, we talk about two areas that
the subcommittee can take a look at. Mr. Shimkus pointed out
one of them is--one of our recommendations is that some Federal
agency has to collect data on franchising. No Federal agency
has collected data on franchising since 1988. That is when the
U.S. Department of Commerce ceased its collection of franchise
data. And no branch of the Federal Government has ever been a
Federal repository for those documents.
Our second recommendation, as in my written statement, is
that we would recommend the FTC to require corporate
franchisors to disclose historical financial performance
information, what Mr. Wharton is calling income claims here, to
prospective franchisees. Let me emphasize historical financial
performance information. We are not talking about what you
might do, projected earnings. Franchisors routinely receive
this information from their small business franchisees in
monthly, weekly, sometimes daily accounting requirements.And
there is no Federal rule, there is no State law that prohibits
disclosure of historical financial performance information.
This is a totally voluntary disclosure in the FTC rule, and
most franchisors simply volunteer not to disclose it. And what
is most ironic about this historical performance information,
99.9 percent of the cases that the FTC took up against
franchisors involved misleading or misrepresented earnings
information to the prospective buyer.
Now, our members also feel that the FTC staff incorrectly
believes their authority does not extend to postsale franchise
relationships, and as has already been pointed out, the GAO's
audit brought some interesting data of its own. Franchise
complaints have increased tenfold. Over 90 percent of those
complaints have to deal with postsale problems or a combination
of pre- and postsale problems.
I mean, what more evidence do you need that the Federal
Trade Commission is asleep at the wheel when it comes to what
are the real problems out there for franchisees?
We believe that franchising has grown significantly from
the 1960's, from its infancy. It then may have been a method of
distribution. It has evolved into a powerful industry, a
largely self-regulated interstate commerce industry. We would
urge members of this panel to consider our point of view. The
relationship between the franchisors, the corporate
franchisors, and the small business franchisees has suffered
from benign neglect for too long, and hopefully this
subcommittee will begin a new debate on the appropriate
guidelines for or future. Thank you.
[The prepared statement of Susan P. Kezios follows:]
Prepared Statement of Susan P. Kezios, President, American Franchisee
Association
Chairman Stearns and Members of the Subcommittee: My name is Susan
P. Kezios. I am the President of the American Franchisee Association
(AFA). The American Franchisee Association was founded in February 1993
and is the largest trade association of small business franchisees in
the United States. We strive in every way possible to promote a
business-to-business relationship predicated upon good faith and fair
dealing because we represent the people who invest in franchised
businesses and who actually work in them. The entrepreneurial men,
women and families who make up our fifteen thousand AFA members own
over 30,000 franchised outlets in 60 different franchise systems. In
the aggregate, we estimate our members have invested, excluding real
estate, more than $7.5 billion in sunk costs to build the brand names
of their franchise systems.
We are grateful for this opportunity to present our views on the
activities of the Federal Trade Commission (FTC) in its enforcement of
its Trade Regulation Rule on Disclosure Requirements and Prohibitions
Concerning Franchising and Business Opportunity Ventures (16 CFR part
436) (aka, ``Franchise Rule,'' ``the Rule,'' or the ``FTC's Franchise
Rule'') because it is our membership, and other would-be small business
franchisees that the Rule was intended to inform in the first place.
Like our counter-parts, the AFA welcomes and supports full pre-sale
disclosure as a means to improve and grow franchising.
The AFA and its members have been active in responding to both the
Commission's Advanced Notice of Proposed Rulemaking (ANPR) and Notice
of Proposed Rulemaking (NPR). In addition, we actively participated in
each of the FTC's series of public workshop conferences held in 1995,
1996 and 1997. All of the AFA's extensive suggestions for improvements
to the Rule and of the FTC's role in enforcing the Rule have already
been put in writing to the Commission. Copies of those suggestions are
attached to my testimony.
The FTC's Franchise Rule was promulgated in 1979 based on 1960's
market conditions. It was crafted to address the dysfunctions of
franchising during the 1960's when franchising was in its infancy.
Certain franchisors and their lawyers worked in those days to hobble
promulgation of the Rule. Change often comes slowly, and at that time,
they fought the Rule like tobacco companies fought the health warning
labeling of cigarettes and automakers fought seat belts. When they
couldn't stop the Rule's promulgation they worked to weaken its
effectiveness. The end result is that twenty-three years later we have
a weak rule with even weaker enforcement. That being said, I would like
the Subcommittee to consider directing the FTC to take action in three
areas that would give the franchise investor more useful, accurate and
complete information in order to make an informed decision. First, we
ask that the Subcommittee direct the FTC to change the language on the
front cover page now required by the FTC to be affixed to each
disclosure document. This cover page reads in part, ``To protect you,
we've required your franchisor to give you this information. We haven't
checked it and don't know if it's correct.'' The cover page then
deputizes the prospective franchisee by concluding with, ``If you find
anything you think may be wrong or anything important that's been left
out you should let us know about it. It may be against the law.''
The FTC's cover page gives two distinct but misleading impressions
to the purchaser of a franchise; first that the ``government'' is
somehow involved in the sale of franchises and is watching out for the
investor's interests and second, that if the purchaser finds anything
wrong, that the government would actually do something about it. That's
the hollow invitation presented by the FTC cover page. It's an empty
invitation because the available data shows they are simply not going
to do anything about the majority of franchise complaints presented to
them. Franchisors know that the FTC cover page warning carries very
little weight; they attach it to their disclosure documents with a wink
and a nod, knowing that it helps them overcome a prospective
franchisee's hesitancy.
The second area on which we would like the Subcommittee to focus
its efforts has to do with the collection of data. No branch of the
federal government has collected data on franchising since the U.S.
Department of Commerce ceased its collection of franchise data in 1988.
And no branch of the federal government has ever been a central
repository for the offering circulars prepared by franchisors.
We recommend that the Subcommittee require the FTC to direct
franchisors to file their offering circulars a minimum of annually with
the Commission. The means are readily available for these documents to
be filed electronically and made available to the public at a modest
cost. This would facilitate the kind of comparison shopping for
franchise opportunities the Rule was originally designed to foster.
The Subcommittee has been provided with copies of at least two
different offering circulars (Domino's and Pizza Hut) to serve as
examples and I would invite Members to thumb through those yellow-page
sized documents. Despite the magnitude of even just the initial
investment required by the small business man or woman interested in
becoming a franchisee, there is no signature of any franchisor officer
anywhere to be found on the circulars. Given the current Enron-inspired
plummet in investor confidence, perhaps another reform would be an FTC
requirement for corporate validation of franchise offerings.
We also recommend that the Subcommittee require the FTC to compile,
analyze and publish statistical information on franchise business
ownership and performance and on national franchise practices. These
reports could finally begin to create a body of comprehensive,
objective and accurate information about the operation of franchise
systems and franchised businesses.
Third, we recommend that the Subcommittee direct the FTC to require
that franchisors provide historical financial performance data in the
disclosure documents they are required to provide to prospective
franchisees. Let me emphasize historical financial data, not
prospective or future anticipated financial estimates. If providing
pre-sale information is important, then it is a fatal flaw of the FTC's
Franchise Rule that disclosure of some measure of financial performance
is not required. The fiction that franchisees can and should buy a
franchise without receiving this most elementary data is well outside
the norm in commercial practices. It is inherently misleading (by
omission) not to disclose historical financial performance information.
A major problem in the go-go 1960's, when franchising was beginning
to roar out of its infancy, was those folks selling franchises and
promising investors they would make specific large amounts of money if
only they bought a particular franchise. You see, corporate franchisors
collect royalties from their outlet owners on sales, not profits, so it
is in the franchisor's best interest to have risk-taking franchisees
open as many outlets as possible. The FTC's requirements regarding
``earnings claims'' (Item 19 in the offering circular) were born out of
that era.
Twenty-three years after its promulgation, franchisors hide behind
and misuse the Item 19 disclosure requirement of the Franchise Rule.
Prospective buyers are told by franchise salespeople that they are
``prohibited by law'' from making any earnings representations. There
is no federal rule or state law that prohibits franchisors from
providing accurate earnings information in the disclosure document.
Providing earnings claims is a voluntary disclosure that the majority
of franchisors, by at least tacit agreement among them, volunteer not
to make.
What is most ironic about the voluntary disclosure of earnings
claims is that of the franchise enforcement cases undertaken by the FTC
during the time period studied in both the GAO's July 1993 and 2001
Reports, 99.9% of the cases cited had to do with fraudulent or
misleading earnings information. Yet, surprisingly, the FTC does not
think the American consumer is entitled to that information.
The worst part about franchisors' not providing historical
financial performance information is that those of us in the industry
know that the information is being given out all the time. Moreover,
this information is readily available to franchisors as they require
franchisees to provide this data to them as part of routine financial
reporting under the franchise agreement. We need to make it mandatory
and we need to make it reliable.
Finally, it is clear to our members, based on the General
Accounting Office's (GAO) July 2001 audit of the FTC's enforcement of
the Franchise Rule that FTC staff believe, incorrectly, that their
authority does not extend to post-sale franchise relationship matters.
Regardless, the GAO audit itself provided some interesting data
including the fact that franchise complaints to the FTC in general
increased ten-fold during the time period studied. Also that 92% of the
franchise complaints that come to the FTC have to do with post-sale
franchise relationship problems (or a combination of pre- and post-sale
problems).
The GAO's 2001 audit did not conclude that there are not franchise
relationship problems, but rather only that there is no data on the
extent of franchise relationship problems. Relationship problems often
occur because of the zealousness of franchisor lawyers who draft the
contracts on behalf of their clients. A variety of clauses are added to
franchise contracts to provide a wide array of weapons that deprive
franchisees of common law rights. These include waiver of jury trial
rights, dispute resolution in distant locations, indemnification for
the franchisor even for its own negligence, one-sided arbitration
clauses and waiver of required bonds to obtain injunctions. The heavily
one-sided, take-it or leave-it franchise agreement we see today would
not be tolerated in any other industry where true competition is a
reality.
While prospective franchisees can always decide not to buy
franchises, many of the provisions our members' find objectionable have
become ``standard operating procedure.'' It doesn't matter if you're
looking at franchise A or franchise B--the agreements for both will
require, for example, that the franchisee waive his/her right to a jury
trial. In other words, as the 1999 AFA study of the top eight pizza
franchisors demonstrated, there is no meaningful choice among franchise
agreements with respect to the legal rights of a franchise. There may
have been true choice between franchise agreements in the 1960's and
70's when the promulgation of the FTC's franchise rule was being
debated, but not today.
Franchisees joke that they're the only small business people who go
to sleep one night thinking they're in one kind of business only to
wake up the next morning in a totally different business. That's
because franchise contracts can and do change during the term. Most
franchise agreements provide that the franchisor can change its
operations manual or other company policies from time-to-time without
notice to or with the consent of the franchisee. In effect, the
franchise agreement becomes a moving target for the franchisee because
the franchisor has the unilateral right to change the terms of the
deal. This is perhaps the biggest threat to a franchisee's sunken
investment because the franchisee typically bears the cost of
implementing whatever change the franchisor decides to make to the
system.
Twenty-three years after its promulgation the consumer approach
taken by the FTC is totally inadequate in protecting the amount of
money and time invested by franchisees in their businesses. Even when
franchisees are given the required disclosures the information provided
is often inadequate, misleading, internally inconsistent, erroneous or
just missing altogether.
Mr. Chairman, we believe that franchising has grown from its roots
as a method of distribution and has evolved into a powerful industry--a
largely self-regulated, interstate commerce industry. We would like to
urge Members of this panel to ponder our point-of-view. The
relationship between franchisor and small business franchisee has
suffered from benign neglect for too long. Hopefully, this Subcommittee
will begin a new debate on appropriate guidelines for the future.
Franchisees have sought more openly disclosed, honest information long
before the Arthur Anderson accounting revelations. We need to have more
accountability from the corporations that offer investment
opportunities and an energized Federal Trade Commission can fulfill its
consumer protection mandate by insisting upon such from corporate
franchisors.
Mr. Stearns. Thank you.
Ms. Wieczorek. Welcome.
STATEMENT OF DENNIS E. WIECZOREK
Mr. Wieczorek. Thank you. Good morning. And thanks for the
opportunity to appear before you, Mr. Chairman, and the rest of
the committee. My name is Dennis Wieczorek. I am a partner in
the Chicago office of the law firm Piper Rudnick. I have been
practicing franchise law for 25 years. I am appealing today on
behalf of the International Franchise Association, which is the
largest association representing the entire franchise
community, franchisors and franchisees.
IFA has been and continues to be one of the most vocal
supporters of the disclosure of a wide range of information to
prospective franchisees. IFA believes that disclosure is
critical when an individual is making such an important
investment decision. If a franchisee and franchisor have a
mutual understanding of the rights and obligations right at the
start, there is a much higher likelihood that they will work
together to make the relationship continue and prosper.
IFA has been an active participant in formulating the rules
of franchise offer disclosure. It participated in the creation
of the Uniform Franchising Offering Circular guideline in the
1970's, and similarly was involved in the overhaul of those
UFOC guidelines in 1993.
A few years thereafter the FTC began the review of its
franchise rules. IFA has had an extensive role in public
workshops and hearings and in preparing written comments on the
rule. While IFA does not agree with all aspects of the rule
revisions that have proposed by FTC, it is clear to IFA that
FTC has bent over backwards to the make the rule revision
process as open and inclusive as possible. We have not yet seen
the final version of the Franchise Rule, but a few comments are
appropriate regarding some of the overall trends already
evident from the FTC's public statements on the rule.
First, it is important to divorce business opportunities
from franchises in any new trade regulation rule. The FTC uses
considerably more resources in enforcement activities against
business opportunities dollars, and there is no basis for
tarring franchising with the same brush.
In addition, the FTC should move toward a single disclosure
format and take all necessary steps to achieve uniformity in
the disclosure process.
While it appears that the FTC is addressing those issues,
IFA will continue to pursue a number of other changes to
improve the Franchise Rule. It is essential that the FTC
recognize the extraordinary costs and burdens that franchisors
must bear in complying with disclosure rules. The FTC must stop
short of creating excessive new requirements that add
unnecessary burdens and unnecessary pages, that erect high
entry barriers to new entrants into the franchise business, and
that unduly complicate the disclosures to be read by
prospective franchisees.
As you know, the General Accounting Office recently
completed a study on enforcement of the Franchise Rule. In
summary, the GAO confirmed that the TFC used most of its
enforcement resources over the last 7 to 8 years on business
opportunities, because the overwhelming majority of complaints
came from buyers of business opportunities, not from buyers of
franchises.
The report also states, and I quote, according to FTC
staff, data the FTC has collected, while limited, suggest that
franchise relationship problems are isolated occurrences rather
than prevalent practices.
The GAO also states in the report that the FTC believes
that it does not have the statutory authority to intervene in
private contractual matters, particularly when there is no
evidence of systemic abuse. IFA believes that this is the right
approach, and that other methods to resolve relationship
problems, the National Franchise Mediation Program, IFA's
ombudsman program, and other internal dispute resolution
programs, are the appropriate way to deal with those issues.
That is where nearly all relationship problems should be
resolved, not in court, and not by a government agency.
In summary, let us allow FTC the opportunity to do its job.
It needs more resources. Let us take care of that. IFA may not
agree with everything that the FTC does, nor with all of the
changes proposed in the new rule, but IFA endorses the FTC's
philosophy of franchise regulation. IFA, like the FTC, believes
strongly in the concept of full and fair disclosure and will
continue to provide its support for the FTC's efforts to
improve franchise disclosure.
Thank you, Mr. Chairman.
[The prepared statement of Dennis E. Wieczorek follows:]
Prepared Statement of Dennis Wieczorek, Partner, Piper Rudnick, on
Behalf of the International Franchise Association
introduction
Good morning, Mr. Chairman and members of the Subcommittee. My name
is Dennis Wieczorek and I am here today on behalf of the International
Franchise Association. I am a partner in the Franchise and Distribution
Practice group of Piper Rudnick, which has served as General Counsel to
the International Franchise Association since the association was
founded in 1960.
Piper Rudnick is a national law firm with offices throughout the
U.S. I have practiced as a franchise lawyer for 25 years and have
worked with clients ranging in size from 1 or 2 unit development stage
entities to some of the world's largest franchise companies.
The International Franchise Association
Founded in 1960, the International Franchise Association is the
oldest, largest and only association that represents the entire
franchise community, with more than 4,000 individual franchisee
members, 30,000 franchisee members represented through their franchisee
associations, 800 franchisor members and 300 franchise supplier
members. Once a franchisor-only association, the IFA leadership
recognized a decade ago that to truly serve as the ``voice of
franchising,'' franchisees should be included as members of the
association. Since 1993, franchisees have been integrated into all
aspects of the IFA, including the Executive Committee, Board of
Directors and committee structure. Currently, a franchisee serves as
Chairman of the International Franchise Association. Another franchisee
is Treasurer of the IFA and five other franchisees serve as elected
members of the IFA Board of Directors.
The IFA's franchisor members include some of the most recognizable
names in the U.S. economy, and many of those companies operate
thousands of franchised units. But the vast majority of IFA's
membership, more than 70%, operate fewer than 200 franchised units and
are themselves small businesses. Regulatory compliance burdens for
those companies can make the difference between success and failure in
the marketplace, which in turn impacts job creation, economic
development and entrepreneurial opportunities for franchise investors,
their families and employees.
One of IFA's goals in expanding membership to embrace franchisees
was to ensure that the IFA speaks on behalf of the entire franchise
community on legislative, regulatory and other public policy
initiatives that affect franchising. The IFA also actively supports
vigorous enforcement of, and thorough compliance with, the FTC
Franchise Rule and state franchise disclosure laws. It is important to
remember that franchising is a business concept in which franchisors
and franchisees must work together to ensure the mutual success of the
enterprise. This requires a careful balancing of both parties'
interests in order to ensure that the regulatory climate promotes
continued growth of franchised businesses.
The IFA's mission is to protect, enhance and promote franchising.
IFA conducts many programs, seminars and conferences to educate current
and prospective members of the franchise community, as well as the
public, about what franchising is and how franchising works. Over the
years, the IFA has adopted and embraced a number of other initiatives
to promote healthy and mutually beneficial relationships within the
franchise community. Primary among these is the IFA's Self-Regulation
program, which includes the IFA Code of Ethics, the IFA Ombudsman
program and on-line compliance and education programs for the franchise
community. The on-line educational programs, Franchise Compliance and
Franchising Basics, were created to ensure that franchisors fully
comply with existing federal and state franchise disclosure laws and
that franchise investors are fully aware of what franchising is and how
franchising works. All of these programs will help minimize long-term
disruption to franchise systems and promote expedited resolution of
business disputes in franchise systems.
The International Franchise Association has also endorsed, and
promoted since its inception, the National Franchise Mediation Program
(``NFMP''), the only program designed specifically for franchising to
assist franchise systems in mediating resolution to business disputes.
In addition, a number of franchise systems, working in conjunction with
the FTC, have created a program known as the National Franchise Council
(``NFC''). The NFC administers an alternative Rule enforcement program
to assist the FTC and franchise companies in addressing minor and
technical violations of the FTC Franchise Rule. These programs,
developed over a number of years by the IFA and the franchise
community, demonstrate a commitment to self-regulation and to the
creation of a business climate in which franchisees and franchisors can
work together to avoid, identify or resolve potential disputes within
individual franchise systems.
What is Franchising and What is the Role of Franchising in the Economy?
Franchising is a strategy for the growth and expansion of a
business in which the franchisor licenses to the franchisee, for a
period of time, the trademark, intellectual property, operating and
business plan and other proprietary information necessary for the
operation of the business. The franchisor also provides training,
support and advertising and marketing assistance necessary to promote
the brand and achieve continued brand recognition and market
penetration. In return for the right to operate this carefully tested
and proven system, the franchisee makes regular royalty payments to the
franchisor, usually on a monthly schedule and calculated using the
gross monthly revenue of the franchised unit as a basis.
Franchise relationships are unique business arrangements based upon
a contract between the franchisee and the franchisor in which the
obligations, rights and remedies of the parties are spelled out in
great detail. Federal and state disclosure laws, such as the FTC
Franchise Rule, identify specific criteria that distinguish a franchise
from other forms of distribution relationships. These criteria include
a registered trademark; the on-going payment of royalties or other
fees; and a continuing and significant involvement of the franchisor in
the operation of the franchised business.
Franchising is not an industry, instead it is a strategy for
business growth and expansion that has been successfully employed by
more than 75 different industries, ranging from hotels to printing to
real estate to restaurants and scores of others. The services and
products offered by these businesses to their customers vary widely, as
do the manner in which companies in these industries operate their
businesses.
Today, franchising accounts for approximately $1 trillion in sales,
or nearly 50% of all retail sales in the U.S. According to the Profiles
in Franchising study conducted by the IFA Educational Foundation, there
are 320,000 franchised units in the U.S. which employ 8 million people.
Franchising is an incredibly successful method of expanding a brand
that has created hundreds of thousands of entrepreneurial
opportunities, giving franchisees the opportunity to be in business for
themselves but not by themselves. In the process, franchising has
created literally millions of jobs and become an engine of small
business growth and development in our economy, and today is
responsible for sharing America's free enterprise values with more than
100 other nations.
The Benefits of Presale Disclosure
The International Franchise Association appreciates the opportunity
to participate in today's discussion of the FTC Franchise Rule and the
effectiveness of the Rule in promoting a healthy and balanced
regulatory climate for the franchise community and American consumers.
The IFA has worked with the FTC since the early 1970's to help craft a
federal disclosure rule that will provide prospective franchise
investors with the information necessary to make an informed business
decision about a franchise investment, while simultaneously maintaining
a reasonable compliance burden for franchise systems.
The IFA has always vigorously supported the enforcement of
disclosure laws because prospective small business franchisees,
franchising and its customers are best served when those investing in a
franchise have all relevant information about the franchise prior to
making the franchise investment. In particular, the International
Franchise Association has been actively involved in working with the
FTC since 1995 on the FTC's proposed revisions to the Rule, and has
appeared at numerous public workshops to discuss those revisions and
submitted a number of written comments (attached to my remarks)
expressing the International Franchise Association's perspective on the
proposed revisions to the Rule.
The International Franchise Association is firmly committed to the
disclosure process because we believe it is critically important for
franchise investors to have realistic expectations about how franchised
businesses operate, and about the interdependent relationship between
franchisors and franchisees. Investing in a franchised business is not
a guarantee of success. Franchised businesses, like any other free
market enterprises, require commitment, hard work and dedication (among
other things) in order to be successful.
One of the IFA's primary functions is to serve as a resource for
the public and potential investors to educate them about what
franchising is, and how franchising works. Franchising is not for
everyone. Franchised businesses are based on the standard and uniform
appearance, operation and delivery of products and services to
customers. This requires franchisees to adhere to, and comply with,
minimum quality standards established by the franchisor for the
operation of the business. The requirement to adhere to operating
standards may be something that is not universally appealing to all
independently-minded entrepreneurs.
The beauty of the franchise disclosure process is that while there
are literally hundreds of franchised businesses from which an
entrepreneur can choose, the disclosure process provides the future
small business franchisee with the framework within which to conduct a
thorough and comprehensive evaluation of those investments. As a result
of this evaluation, the franchise investor can make a decision about
which, if any, is the right investment. That is one of the reasons that
the IFA promotes and distributes the FTC's Consumer Guide to Buying a
Franchise. For years, the FTC Guide has been republished in IFA's
Franchise Opportunities Guide, posted on our website and disseminated
to thousands of news media outlets to increase public awareness. The
FTC Guide provides franchise investors with guidance about what
information is important in evaluating a franchise and how to obtain
and evaluate this information. The Guide also recommends that franchise
investors retain professional services of legal and financial experts
to assist in a thorough evaluation of all presale information obtained
as part of the disclosure process.
This evaluation also requires a considerable amount of self-
evaluation and introspective thinking about the business or industry in
which a franchise investor wants to be involved. If the prospective
investor determines that none of those investments are attractive, the
future entrepreneur is free to establish his or her own independent
business. The disclosure process provides the information necessary to
reach a fundamental decision about whether to make the investment, and
to compare between and among franchise systems in order to find the
franchised business that matches an individual's interests, skills and
needs.
The FTC Disclosure Rule and Proposed Revisions
As noted earlier, the International Franchise Association's
longstanding support for the disclosure process is rooted in our belief
that disclosure regulations strike the appropriate balance between the
investor's need for information and the legitimate concerns of
franchise systems about overregulation in the marketplace. The IFA
commends the FTC staff for the manner in which they have conducted the
process leading to the review of the franchise rule. We have actively
participated in this process, beginning in early 1995 with the informal
request for comment, the first public workshop in September 1995, the
subsequent workshop in March, 1996, the Advanced Notice of Proposed
Rulemaking in early 1997, the subsequent regional workshops held around
the country in 1997 and the Notice of Proposed Rulemaking in 1999. We
believe that the inclusive and thorough approach adopted by the FTC in
this rulemaking effort resulted in a process that provided ample
opportunity for all interested parties to participate, and has produced
a record that clearly identifies the areas addressed by the Rule that
are most in need of revision.
GAO Audit
The IFA also participated in numerous discussions with the General
Accounting Office (``GAO'') during the 2000-2001 audit conducted by the
GAO on the Enforcement of the FTC Franchise Rule. We believe that the
results of the GAO audit affirm our long-held beliefs that: (1) the
vast majority of complaints alleging violations of the franchise rule
(more than 92% according to the GAO) involve business opportunities,
not franchises; (2) the FTC effectively enforces the Rule; and (3)
there is no empirical data to support the notion that there are
pervasive problems in franchise relationships.
According to the July 31, 2001 GAO Report on Franchise Rule
Enforcement:
From January 1993 to June 1999, a seven year period, the FTC
received 3,680 business opportunity and franchise complaints,
with 92% involving business opportunities and 8% involving
franchises. (GAO-01-776, pages 3,10)
During the same period, and after analyzing complaints, the
FTC launched 332 investigations. 162 cases went to court for
violations of the Franchise Rule and/or section 5 of the FTC
Act (which declares unlawful unfair or deceptive acts or
practices in or affecting commerce.) (GAO-01-776, pages 13,16)
Of the 162 cases, 88% or 142 involved business opportunities,
only 12% or 20 involved franchises. In each of the 162 cases
brought to court, the FTC obtained some form of relief,
including injunctions, civil penalties or monetary redress for
investors. (GAO-01-776, pages 3,10)
Since the Franchise Rule review process began in 1995, the FTC
has received comments or statements for the record from a total
of 96 individual franchisees or trademark-specific franchisee
associations. FTC staff noted that nearly half of the comments
submitted were identical form letters that discussed their
general support for broader franchise relationship controls but
shed little, if any light, on their specific experiences. FTC
staff also reported more than half of the comments raised
issues involving only three franchisors. The FTC said there was
little consistency among the remaining individual comments,
which covered a wide range of issues. (GAO-01-776, page 22)
FTC staff stated that the isolated instances of franchise
relationship problems do not justify FTC conducting a more
widespread investigation of relationship issues or developing a
new rule that addresses the terms and conditions of franchise
contracts. (GAO-01-776, page 23)
According to FTC staff, data the FTC has collected, while
limited, suggest that franchise relationship problems are
isolated occurrences rather than prevalent practices.'' (GAO-
01-776, page 4)
IFA Comments on Proposed Revisions to Franchise Rule
The attached written comments submitted by the International
Franchise Association to the FTC as part of the rulemaking process
spell out in great detail the specific areas in which we believe the
Rule should be revised. I will not repeat in detail each and every one
of those comments in these remarks. However, I would like to highlight
several issues of great interest to the International Franchise
Association and its members which we believe are among the most
important aspects of the proposed revisions to the Rule.
The FTC and UFOC
The FTC disclosure format coexists with a franchise disclosure
format developed by a number of states called the Uniform Franchise
Offering Circular (``UFOC''). The UFOC disclosure format and the FTC
format are similar, but not identical, and the UFOC disclosure format
is required in nearly all of the states that have enacted their own
franchise disclosure laws. The FTC disclosure format is not accepted in
those states.
Both the FTC and UFOC disclosure formats require, among other
things, the disclosure of such items as the business experience of the
franchisor; its litigation and bankruptcy history; franchise fees,
royalties and other payments required under the franchise agreement;
requirements for purchase of inventory, equipment or supplies;
territorial restrictions; transfer or termination of the franchise; and
financial statements; and contact information for current and former
franchisees of the system. However, there are differences between the
format and detail required under the FTC and UFOC documents, which can
generally be described as deficiencies in the FTC format.
Adoption of UFOC Format for Disclosure
One of the proposed changes to the FTC Rule is to adopt the UFOC
format for disclosure, which would enhance uniformity of the disclosure
document that franchise investors receive and would simultaneously
streamline and simplify the disclosure process for franchisors. And
because state regulators updated their disclosure format several years
ago, by adopting the UFOC format the FTC will not only harmonize its
rule with the state format, but will also significantly modernize its
rule. The IFA strongly supports this proposed change to the FTC Rule.
Separate Rule for Franchises and Business Opportunities
The IFA also supports the recommendation that business opportunity
ventures be removed from coverage of the Franchise Rule. We believe
that the structure, operations and experiences of business format
franchises--IFA's members--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.
Electronic Disclosure
We also strongly support a revision to the Rule to permit
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 select portions of the
disclosure document undermines the effectiveness of this provision.
However, we believe that if the FTC adopts a mechanism that will permit
minor revisions to this requirement as electronic filing becomes more
prevalent, the Rule may preserve the beneficial effects of electronic
disclosure for both franchisees and franchisors.
Application of Rule to Exclusively Domestic Franchise Sales
The IFA also supports the FTC recommendation that the rule be
clarified to reflect its application to exclusively domestic--as
opposed to international--franchise sales. We agree that there is no
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.
Earnings Claims
Finally, the IFA strongly supports the FTC's recommendation that
the Rule not contain a mandatory earnings disclosure. The IFA believes
that a mandatory, one-size fits-all approach to financial performance
information is impractical and could actually impair the advance of
free enterprise franchising, as it fails to take into consideration the
many variations that exist among the scores 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
available, either directly from franchise companies that make earnings
disclosures or through direct communication with current and former
franchisees. IFA believes that the competitive force of the marketplace
should drive the decision-making process regarding whether or not
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.
Conclusion
Let me conclude by thanking you, Mr. Chairman and the members of
the subcommittee for giving the International Franchise Association the
opportunity to appear here today to discuss these important issues. The
IFA strongly believes that the FTC disclosure rule has had a positive
impact on the evolution of franchising, and that the Rule has helped
create a climate in which thousands of businesses and tens of thousands
of entrepreneurs have had an opportunity to achieve the American dream
of being in business ``for themselves, but not by themselves.''
The IFA believes that the proposed revisions to the FTC Franchise
Rule will be beneficial in modernizing the Rule, and ensuring that
prospective franchise investors have ready access to meaningful and
reliable information about franchise investments. Armed with this
information, entrepreneurs can conduct due diligence in researching
these franchise investments, make informed decisions about their
investments and enter the small business franchise community with
realistic expectations about what franchising is and how franchising
works.
As ``The Voice of Franchising'' for more than 40 years, the IFA
will continue to work with the FTC to complete revisions to and
implementation of the revised Franchise Rule.
Thank you again for inviting me to appear here today. Good morning.
Mr. Stearns. I thank you.
And Mr. Rizer. Welcome.
STATEMENT OF JERRY RIZER
Mr. Rizer. Thank you. My name is Jerry Rizer. My home is in
Elizabethtown, Kentucky. I own and operate three Dairy Queen
stores. I have been a Dairy Queen franchisee operator for 20
years. I am also the president of the Dairy Queen Operators
Association, and the Dairy Queen Operators Cooperative, which
represent over 1,400 DQ franchisees and 3,900 DQ franchisees
respectively.
The Dairy Queen system in the United States employs
approximately 160,000 people including many teens holding their
first jobs. In the aggregate we purchase as much as $400
million annually in equipment and supplies.
The FTC rule and its enforcement of the rule has been
woefully deficit in three major ways. No. 1, the rule affords
us no protection against the most dangerous threats to our
existence: abuse of competition by our franchisor in our supply
chains, and encroachment on our developed stores by new stores
franchised by our own franchisor.
No. 2, astonishingly the rule allows big franchisors like
IDQ to sell franchises without disclosing track records of
financial performance of existing franchised stores, and
without disclosing the financial impact on new or existing
franchisees of IDQ's manipulation of supply chains or
encroaching new store development.
No. 3, Federal law does not allow franchisees who are
injured by franchisors' blatant violation of the rule through
deceptive misdisclosure, or omission of material information,
or even outright fraud to bring a legal action to recover their
losses cause by the violation.
Mr. Chairman, we know that you are aware of the findings of
the GAO audit last year of the FTC's enforcement of franchising
rule, that the vast majority of franchise complaints of the FTC
involve postsale relationship problems, like those described
above, that the FTC doesn't even investigate the vast majority
of even the legitimate franchise complaints it receives, and
that in the last 5 years the FTC has brought only legal
enforcement action against a franchisor during a period when
literally thousands of private lawsuits have been filed under
State franchise laws where those exist.
It is absolutely incomprehensible to our association that
franchisors can violate the FTC rule with apparent impunity
because the FTC lacks the resources or the will to enforce its
own rules, and Federal law does not provide private parties the
right to sue for harm caused by violations of the rule. The
rule is a paper tiger.
Mr. Chairman, it would be a simple matter indeed for
Congress to redress this travesty with legislation as simple as
amending the Federal Trade Commission Act or the Clayton Act to
add this: Section blank. A person who is injured by a violation
of the trade regulation rule on franchising, CFR Part 436, as
it now exists or as it may subsequently be amended or
recodified may bring an action against the person who committed
the violation in a State or Federal court of appropriate
jurisdiction for damages, rescission, cancellation, or such
other relief as the court deems appropriate, and is entitled
also to recover the person's costs and attorney fees to obtain
relief.
If, as the franchisors and their trade association assert,
all is well in franchising, and presale disclosure cures
whatever problems exist, the private right of action will not
produce any measurable burden on the court system or the
franchisors. Courts have ample power already to sanction
frivolous or unfounded complaints, so that is not an issue. But
where real harm has been caused, it will for the first time
afford at least the opportunity for justice to be done.
Thank you for consideration of these views.
[The prepared statement of Jerry Rizer follows:]
Prepared Statement of Jerry Rizer, President, Dairy Queen Operators
Association, Inc.
The Dairy Queen Operators Association (``DQOA'') and the Dairy
Queen Operators Cooperative (``DQOC'') presents these views to the
Committee for its oversight of the United States Federal Trade
Commission's enforcement of its Trade Regulation Rule on Franchising
(16 C.F.R. Part 436) (the Rule).
DQOA/DQOC is an independent trade association and cooperative
representing the interest of more than 3.900 Dairy Queen stores in the
U.S. owned by American entrepreneurs. The typical Dairy Queen owner
owns just one or two store(s), and for most, this investment represents
substantially all of the owner's (and his family's) net worth. Dairy
Queen franchisees are owner-operators--they get their hands dirty
working these stores themselves.
Dairy Queen franchisees in the U.S. employ approximately 160,000
people, including many teens holding their first jobs, learning the
virtues of hard work, punctuality, and serving customers. In the
aggregate, we purchase as much as $400 million annually in equipment
and supplies. A new Dairy Queen store can cost as much as a million
dollars to build.
The business is highly risky. Under the best circumstances, the
pre-tax operating margin on a. Dairy Queen/Brazier store, before
allocating profit to the owner, is just 10%, leaving very little to
compensate the owner for his or her hard work and investment. We pay a
``tax'' to our franchisor of 4% of our top line sales, and a mandatory
``tax'' to a national marketing fund 100% controlled by our franchisor
of as much as 6%. We therefore have only 90% of our sales to cover our
payrolls, our vendors' bills, our bank loans, and our real taxes, and
that all comes after our franchisor, who always gets ``first dollar.''
With what amounts to a razor-thin margin, our franchisees struggle, to
earn a minimal return on investment and a living income with the last
dollars left after everyone else is paid.
We have had severe challenges running our businesses and making our
payrolls, and some of the worst of these come from our own franchisor,
International Dairy Queen, Inc, (``IDQ''), which is owned by multi-
billionaire Warren Buffett's company, Berkshire-Hathaway.
The FTC's Rule and its enforcement of the Rule has been woefully
deficient in three major areas:
1. The Rule affords us no protection against the most dangerous threats
to our existence abuse of competition by our own franchisor in
our supply chains, and encroachment on our developed stores by
new stores franchised by our franchisor.
2. Astonishingly, the Rule allows big franchisors like IDQ to sell
franchises without disclosing the track record of financial
performance of existing franchised stores, without disclosing
the financial impact on new of existing franchisees of IDQ's
manipulation of supply chains or encroaching new store
development.
3. Federal law does not allow franchisees who are injured by a
franchisor's blatant violation of the Rule--through deceptive
misdisclosure, or omission of material information, or even
outright Fraud--to bring a legal action to recover their losses
caused by the violation.
rule omissions
Sourcing. The Rule mandates selected disclosures prior to the sale:
of a franchise. But, it does not even address the many pernicious
practices of many large franchisors such as IDQ which cause widespread
and significant harm to franchisees.
IDQ was not content to receive just its 4% off-the-top royalty and
5 to 6% marketing fee (part of which covers IDQ's corporate costs
relating to advertising and marketing). IDQ also took enormous fees,
which many of our members regard as naked kickbacks, from suppliers
based on franchisees' purchasing volume. IDQ also took huge markups on
goods it resold to franchisees. And to protect this huge income stream,
IDQ abused its market power over the Dairy Queen system to try to keep
franchisees--through their independent purchasing cooperative--from
using independent competitive sources for equipment and supplies. IDQ's
abuses of sourcing cost our system tens of minions of dollars of
unnecessary and avoidable costs every year. The Rule doesn't even
address these abusive and anticompetitive practices.
In 1994 we were forced to sue IDQ to stop the practices. Because of
the deficiencies in federal law, it was an uphill fight. In 2000, we
finally settled the case, but IDQ has still not cooperated with its own
franchisees. preferring to try to hold onto its huge sourcing revenues.
It took us six years of hard-fought litigation to reach a compromise
settlement because the FTC Rule does not prohibit franchisors from
abusing their authority over sourcing, to allow the free interplay of
normal competitive forces in the marketplace to work for franchisees.
And federal courts have declined to apply normal principles of
antitrust law to franchise systems, allowing franchisors to monopolize
and abuse supply chains in their systems to the detriment of
franchisees who are locked in by the iron chains of grotesque franchise
contracts drafted by huge: franchisor law firms without the chance for
franchisees to negotiate or influence the terms of those contracts.
Encroachment. Those same one-sided. oppressive contracts allow. and
the FTC Rule does not even address, big frannchisors like IDQ to
compete against their own franchisees by encroaching on established
franchisees with new stores. The franchisor profits, the franchisees
lose, and the Rule ignores the whole problem.
Here is an example to illustrate our plight. Suppose a town has an
established Dairy Queen (or any other franchised small business).
Suppose the existing store has annual gross sales of $700,000. IDQ gets
the first 4% of that, or $28,000. Suppose IDQ franchises a second store
in that same market, with the result that their combined sales are $1.1
million. IDQ's take goes up to $44,000, but each store only takes in
(on average) $550,000. The existing franchisee's sales have dropped by
$150,000, which is probably more than that owner was making before the
encroachment occurred. In other words, Warren Buffett's franchisor's
income went up by more than half, but the franchisee lost his entire
profit, or a very large part of it.
The FTC Rule allows this to occur. The FTC Rule doesn't even
require disclosure of this impact much less prohibit this kind or
plainly unfair trade practice. And this happens every day throughout
this country.
I would venture to guess that no franchisee anywhere bought his or
her franchise expecting his own franchisor to become his biggest
competitive nightmare. Yet federal law allows this to happen.
Financial Disclosure. I was shocked when I first learned that the
FTC Rule allows franchisors to sell franchises without telling their
prospective buyers how existing units are doing financially, or what
the buyer might expect to do with his franchise. What could be more
basic or more important to a buyer than financial performance data? Our
franchisor already has the data, and I'm sure most others do, too. But
they are allowed conceal that vital information because the Rule makes
that disclosure optional.
What if the franchisor knows that a large portion of its
franchisees are struggling financially? Why in the world should the FTC
allow the franchisor to hide that from a prospective new franchise?
The same is true of disclose of the financial impact of franchisor
interference with free competition in sourcing, or of franichsor
encroachment. Why shouldn't the FTC require a large franchisor like IDQ
or McDonald's or Holiday Inn to have to disclose such simple data as:
``Our involvement in the supply chain in this system adds about
x% to your costs of doing business,'' or
``If we use our right to encroach on your franchise, it may
take away as much as 50 to 100% or more of your operating
profit.''?
private remedies
Mr. Chairman, we know that you arc well aware of the findings of
the GAO audit last year of the FTC's enforcement of the Franchising
Rule that the vast majority of franchise complaints to the FTC involve
post-sale relationship problems like those described above, that the
FTC doesn't even investigate the vast majority of even the legitimate
franchise complaints it receives, and that in the last five years the
FTC has brought only one legal enforcement action against a franchisor
(during a period when literally thousands of private lawsuits have been
filed under state franchise laws where those exist).
It is absolutely incomprehensible to our association that
franchisors can violate the FTC Rule with apparent impunity, because
the FTC lacks the resources or the win to enforce its own Rule AND
federal law does not provide private parties the right to sue for harm
caused by violation of the Rule. The Rule is a paper tiger.
Mr. Chairman, it would be a simple matter indeed for Congress to
redress this travesty with legislation as simple as amending the
Federal Trade Commission Act, or the Clayton Act, to add this:
Section. ---- A person who is injured by a violation of the
Trade Regulation Rule on Franchising, C.F.R. Part 436, as it
now exists or as it may subsequently be amended or recodified,
may bring an action against the persons who committed the
violation in a State or federal court of appropriate
jurisdiction for damages, rescission, cancellation or such
other relief as the court deems appropriate, and is entitled
also to recover the person's costs and attorneys fees to obtain
relief.
If as the franchisors and their trade association assert all is
well in franchising and presale disclosures cure whatever problems
exist, this private right of action will not produce any measurable
burden on the court system or the franchisors. Courts have ample power
already to sanction frivolous or unfounded complaints, so that it is
not an issue. But, where real harm has been caused, it will--for the
first time--afford at least the opportunity for justice to be done.
Thank you for your consideration of these views.
Mr. Stearns. Thank you.
Let me just say, Mr. Rizer, if we allowed a franchisee to
sue in his State, then you would have 50 States in which you
would have suits, and in all deference to the company, you
know, you can have a lot of nuisance suits. It can drive a
company out of business. So the idea of allowing private right
of action in each State--now, Mr. Rush and I might not agree on
this, but I have some concern of allowing a franchisee to sue
in separate States.
I notice here in Pizza Hut, they say if you are going to
sue, it will have to be in Kentucky. I think it says--anyway,
they specify where you have got to sue. You can see that
perspective, can't you, that it would just be very difficult
for a company to sustain litigation from 50 States, going into
50 different courts? That is just a comment.
I think what you suggested and what others have suggested,
including mandatory earnings disclosure in its revised
Franchise Rule, I think is good. Can I just ask down the panel,
do you think the idea that the FTC should--although right now I
understand they are not including mandatory earnings disclosure
in its revised Franchise Rule, do you think that they should?
Mr. Cantone. Speaking for NASA, NASA has been on record for
years as supporting in concept mandatory earnings disclosure,
and, in fact, NASA had worked for the last several years to try
to propose mandatory earnings claims at the State level. But
for practical reasons, and one of the main reasons is because
the Federal Trade Commission has signaled it is not going to
mandate earnings claims, it kind of made us stop on that
process for the time being because of issues of uniformity.
So we think if there is mandatory earnings disclosures
which support in theory, it is best to be adopted on a uniform
national basis because of issues of uniformity so that
everybody has the same rules and not just rules in certain
States.
Mr. Stearns. My question, though, then the parent company
has to come up with historical data. That might be for a good
operator. But you have a weak operator, and the person who gets
it will say, I didn't get those figures. That is because you
didn't do what the company told you to do. That historical
information has some problems with it, depending on the
operator, whether he does what the franchisor tells him what to
do, and whether he has good business sense, whether he is
putting capital in the property. If he just drains the property
dry, and you show up and there is no flowers, there is
dirtiness in the restaurant or motel room, it doesn't matter
what the historical data shows. You cannot sue based upon your
lack of performance. So those are one of the problems.
Go ahead.
Mr. Wharton. I addressed it a little bit in my remarks, Mr.
Chairman, but basically I think that there is a practical
problem in trying to get--because it is so diverse. Franchising
is not----
Mr. Stearns. So you don't think that you could come up with
a standardized historical information that would be applicable
which the franchisee could take to the bank?
Mr. Wharton. I think it would be very difficult, and I
think that the alternate is to get it from--what we suggest
when someone is coming in is talk to as many of those existing
owners. They are all listed in our UFOC. Talk to them.
Mr. Stearns. Make them do the due diligence before they
buy.
Mr. Wharton. Exactly. Find people that are not doing well.
Make sure you find someone that is not doing well. Understand
why.
Mr. Stearns. I have a friend who opened up a Burger King,
and he did it in university town, and he did real well until
the university had a Burger King within the student union. It
took all of his business, so he is thinking about suing. You
know, you could have given him historical data. It wouldn't
have been meaningful for his site. It might have showed that
you are going to make a million dollars in gross a year, but if
someone opens up and the student union has it right there, then
no one is going to go off campus to get it. So, you know, go
ahead.
Ms. Kezios. Not having historical financial performance
information when you buy any business is not done in any other
commercial activity except franchising. Why should franchisees
have to buy a business and guess perhaps at what franchisees
have done in the past? I used to be a franchise broker 20 years
ago. The joke was, as we were selling franchises, if the
franchisors had to report historical financial performance
data, half of the franchisors wouldn't be franchising today
because people can't make any money.
Now, I have got a document here from Growbiz International,
their uniform franchise offering circular. They are providing
an Item 19. So for some reason they found it easy. They have
got the data. Franchisors get this data, Mr. Chairman. Some
days at the end of the day they know exactly what the
franchisees have done. This is like buying a car without an
engine. It doesn't make any sense not to have historical
financial performance data.
Mr. Stearns. Okay.
Mr. Wieczorek. This is a remedy. This is a remedy in search
of a problem. If franchisees are interested in a business, they
should talk to every conceivable person that is listed in the
document. If someone is a prospective Dairy Queen operator,
they can call up Mr. Rizer and say, how are your stores doing?
That is what they should do. That is incumbent on them to do
it. Information is available now.
Mr. Stearns. It is like when a person goes in to buy a
business, you know, you have to do the due diligence to find
out--if the owner says, we are grossing XYZ, you better look at
the sales tax to be sure that is true. You probably should sit
there and look at the business, to see what goes in, because
lots of times, unless you do your due diligence, those
historical figures don't mean much.
Mr. Rizer.
Mr. Rizer. There is an inaccuracy here in what people are
saying. The document that you are showing up here doesn't list
a list or is not required to list a list of current and former
franchisees, or at least it is not being complied with at the
present time. So as the fellow next to me is suggesting they
call me, they would only call me if my name and number was
listed. The uniform offering agreements that I have received
list only those locations in the State that I reside.
Mr. Stearns. But Pizza Hut, it looks like it has all of the
open franchise stores. I mean, there is just gobs of names here
that I could call.
Mr. Rizer. I received the document. I received one a few
weeks ago. It only had Kentucky in it. That is all I have ever
been told was required.
Mr. Wieczorek. Most franchisors will list all of their
franchisees, but the guidelines do permit you to list at least
100 in the State that you are in or States contiguous to you.
So every UFOC will have at least 100 franchisees listed in it,
but they must include all former franchisees who left the
system in the last year. So there is another group that they
can talk to also.
Mr. Stearns. My time has expired.
Mr. Rush.
Mr. Rush. Mr. Wharton, you testified against requiring
earnings disclosures because each business is different.
However, the SEC, the Securities and Exchange Commission, has
been successfully requiring uniform earnings disclosures of
publicly traded companies for decades. Now, how is this any
different? And I would like for all of the panelists to take a
stab at this. Be brief if you can.
Mr. Wharton. Basically, Congressman, I think that one of
the issues is that the information that is gathered in the
franchise context has to come from the owner themselves or the
franchisee that is out there in the market, and they may or may
not provide accurate information for various reasons. With the
SEC rules, you are reporting on information that your company
has control over.
Ms. Kezios. Well, the argument that you have no control
over what the franchisee reports is moving the question. I
mean, the franchisee is reporting the information. That is what
you put in the document. I mean, that is avoiding the question
totally.
Mr. ZWieczorek. Congressman, the only information that a
franchisor usually gets is sales information. It does not get
on a consistent, reliable basis cost and expense data from
franchisees, so that, in effect, what a lot of people are
saying is that you should give earnings. It is almost
impossible to give earnings because you can't get that data
from franchisees, you can only get top line sales data.
Ms. Kezios. In certain franchise chains, they do have all
of that information. They know exactly. They prepare the
financial statements for the franchisees. So it is not standard
what Mr. Wieczorek is just mentioning.
Mr. Rizer. I have got three letters at home from
International Dairy Queen's attorney requesting that I provide
a P&L listing the sales, the cost of goods, the expenses in
each and every category. This comes once a year to me, and I
provide that information.
Mr. Rush. Mr. Cantone.
Mr. Cantone. Most franchisors don't provide any
information, including gross sales information. The numbers
that we are saying are approximately 80 percent of franchisors
provide absolutely no earnings information at all, and I think
that is something that a prospective franchisee should take a
look at as to what is the answer to that question: Why are you
not giving this information? And I think it can be very
telling. It is very difficult for franchisors, however, to put
together really meaningful earnings information. It is a very
complex area, but I do think it is something that franchisors
should really strive to do, and they haven't done it
voluntarily, so I think the time certainly is right for
somebody to take a hard look at whether or not they should be
forced to do it.
Ms. Kezios. In the 1960's when the rule was promulgated,
the reason that this disclosure is a voluntarily disclosure is
because there were folks in those days selling franchises
saying, give me $10,000; you will make $1 million next year.
That is why that was put--this is 23 years later. That doesn't
happen anymore. Those guys don't sell franchises like that.
They know how to sell them without making that kind of a
blatant earnings disclosure.
What is worse is we know that the information is being
given out there, perhaps not in that blatant a manner, but it
is being given out there, and we need the information in a
document. We need it reliable, and we need it accurate.
Mr. Rush. Ms. Kezios, the FTC states, based on the data
they have, that franchise relationship problems are isolated
occurrences. Why aren't there more franchise complaints against
those kinds of postsale franchise relationship problems to the
FTC?
Ms. Kezios. The 1993 GAO audit of the FTC was like putting
a neon sign on the door of the Commission saying, don't bother,
franchisees, because the 1993 audit pointed out that the FTC
acted on less than 6 percent of all franchise complaints
brought to it. So franchisees are, why do we even bother?
Susan, why are you telling us to complain with the FTC for?
Which we have continued to do, which is why we surmise there
has been an increase in the complaints.
Now, the FTC data doesn't reveal the full extent and nature
of franchise relationship problems. They don't have enough data
to begin with. So for them to make that conclusion is erroneous
to begin with. They don't have enough data on the franchise
relationship problems.
I would say that over 90 percent of the complaints that
come to me have to do with postsale or a combination of pre-
and postsale. What bigger number do you need to show that a
preponderance of the complaints have to do with postsale?
Mr. Rush. Mr. Wieczorek, what types of litigation, if any,
do franchises have to list in their disclosure documents?
Mr. Wieczorek. Right now a franchisor is required to list
all claims made against them by franchisees and also any
counterclaims that may be made by a franchisee if a franchisor
sued the franchisee. There is a requirement that it be
material. If someone sues you for 10 cents, you don't have to
put that in, but any material litigation does have to be
disclosed. And that goes for current actions, plus you must
report all litigation that has been resolved unfavorably
against the franchisor for the last 10 years.
Mr. Rush. Mr. Chairman, I got one additional question. Let
me just ask this question.
As I traveled through America, you know, a lot of times by
car, and I go to different communities, I am always astonished
by in the--in some communities there is a lot of franchise
options for consumers, a lot of different stores. But when I
return home to central city America, to my own Chicago, then I
can count maybe on one hand the number of franchises that is
really being in business in communities like mine.
I wonder if someone can give me some idea about what is the
difference there? I know that there are--all of the expert
testimony and all of the research says that in central city,
low-income areas, sales are explosive in terms of consumer
sales. Every time there is a Kentucky Fried Chicken franchise
opened up, or Burger King franchise opened up something, they
always break records. I remember when McDonald's first came to
the west side, on the west side of Chicago, on Madison, broke
all kinds of records for the first few months of operation.
But it seems as though there is a barrier, some kind of
wall. We can't get more franchised business located in central
city communities. Can anybody take a stab at that, or is that
something that you have looked at or thought about? If not, I
would like to invite you to tour some of those communities and
see the differences, because, I mean, it makes excellent
business sense. And I am not sure if there is just not--you
don't see the opportunities. Sometimes we can only see the
opportunities in our background because that is where we focus
at, but I am telling you there is a real serious issue in terms
of diversity in terms of franchise opportunities, certainly in
my community.
Mr. Wieczorek. One of the main issues is capital, and these
days with the banking and financial industry the way it is, it
is difficult to find capital for anybody to expand. But
franchisors in a number of concepts, particularly in the food
business, are trying to open more doors to minorities and women
and others to open franchises, but a lot of it is a lack of
capital in trying to find financial resources to get those
businesses open.
So I think that there are efforts to do that, but it is
difficult in these economic times.
Mr. Rush. I want to work with you on that, because I don't
think that is really the case. I really don't think--I mean, I
think it is a question of having a determined approach to it.
Thank you, Mr. Chairman.
Mr. Stearns. Thank you.
Mr. Shimkus.
Mr. Shimkus. Thank you, Mr. Chairman. And I will wax
philosophically for a few minutes before I ask a question or
two.
First of all, we appreciate the jobs and economic
development, growth of both the franchisors and the
franchisees. This is a debate of being torn between two lovers
and trying to pick out--trying to slice the baby and figure out
what we need to do. A lot of our experience up here is--mine
would be based upon a Flintstones episode where Barney and Fred
wanted to buy a--I think it was a tyrannosaurus rib shack. And
so the local used car dealer next to them put a whole bunch of
cars around the little restaurant, and they bought it,
obviously. They weren't well informed. And they couldn't turn a
profit. And I actually remember the jingle from the waitresses
who were trying to sing the song as they were trying to get
people to work there.
So what you would like the--you really need to get together
and solve this problem before you encourage us, either through
pressure to the FTC to change things where our lack of
expertise might actually end up doing more harm than good on
both sides.
But I tell you one thing that I think many of us feel,
especially those who support small business across the board,
small or large businesses, is the whole basic principle of
legal certainty. Businesses will not get capital investment in
areas if there is no legal certainty, in the inner city, maybe
brownfields redevelopment; in a small franchisee it might be
lack of legal certainty, the cause of lack of a moving target
on a contractual signing with the franchisor, which I find just
really ridiculous that a franchisor would offer a contract to a
franchisee that could change. I mean, how in the heck does
someone have any legal certainty for a period of time to try to
project capital investments, costs and a return on their
investment?
So I would encourage, as we move to push the FTC to move
forward in promulgating a rule or amendments to the rule, that
if we don't fall into the same problem as identified in the
1979 rule based upon 1960 experience, that we don't promulgate
2002 amendments to the 1979 rule that are based upon 1980
experiences, because we don't want to be back here in 15 years.
So let me ask, are the abuses that are identified in some
of the reports, we have got--the Attorney General's office, you
probably get abuses.
Mr. Cantone. We hear about abuses all of the time, but I
don't think we hear about abuses to the extent they exist in
the marketplace for some of the same reasons that we have
talked about. I go out and speak to franchisees and hear
stories about renewal problems or encroachment issues, but for
many reasons franchisees don't complain to my office because
they don't complain to the FTC because they realize we don't
have jurisdiction to handle these issues.
We haven't had a complaint about encroachment in our office
for more than 5 years, but we hear time and again that it is a
real issue.
Mr. Shimkus. Which would be the example of the chairman's--
with the university. That would be an encroachment issue.
Mr. Cantone. Absolutely. I hear from Ms. Kezios, from her
and her members. So we realize it is an issue, it is a concern.
And a lot of franchisors do not provide protected territory,
which leaves franchisees open to the possibility that they
could have a competing franchise across the street from their
same franchisor.
Mr. Shimkus. Mr. Rizer, so you are operating as a
franchisee for a Dairy Queen, but the International Dairy Queen
could, in essence, locate within a geographical area that you
are now serving?
Mr. Rizer. If they wanted. There are ways. Yes. Now,
regardless of----
Mr. Shimkus. Regardless of what contractural arrangements
you have made in the past.
Mr. Rizer. Right. There are ways. You asked a question
about FTC complaints. I am surprised that you have any. I am a
small businessman. I am independent. I go in, and I work my
store. I normally get up at 4:30 in the morning to go to work,
and my day doesn't end until 3, 4 in the afternoon, and I am in
bed at 7. Great. I don't have time to call and complain to
someone else, let alone the government, which I really don't
see as being something to solve my problems.
Most Dairy Queen franchisees that I know are independent.
They take care of their own problems, and until yesterday, I
didn't know I could complain to the FTC. As a matter of fact,
we went through a lawsuit with International Dairy Queen in the
1990's, early 1990's, and we did have our executive director
and counsel go to the FTC and the Justice Department with
complaints, and we were told, well, you have an action here for
a lawsuit, sue them.
Well, we weren't looking to sue. We wanted a good
relationship with our franchisor, but we were told we had to
sue to get any redress to our grievances. We did that, and we
won, in our opinion, won the lawsuit and money to go along with
it.
It was ultimately a settlement. We are happy with that. But
we didn't want to sue them, we want to get along.
Mr. Shimkus. This UFOC--and I can't--I don't remember the
acronym. I would like it up. Do you have great hopes that that
will be helpful if the FTC offers that as part of the
amendments to the 1979 rule? Does everyone agree with that?
Mr. Cantone. Absolutely. The UFOC is far superior. As a
matter of fact, we have been talking about these required
disclosures, like the list of franchisees and other issues. We
are talking about the UFOC. If you look back at the FTC rule,
for example, that is why in Kentucky you only have a list of
Kentucky. The UFOC requires 100 franchisees in the State and
surrounding States. That is just one example.
The UFOC is far superior to the FTC disclosure document,
which really is kind of an anachronism in 2002.
Mr. Shimkus. When do you think--since the FTC, which you
all heard me talk about has been 5 years in promulgating the
amendments to the rule, and, as we also observed, they really
weren't very assertive in actually giving a parameter when we
might see some timeframe in these amendments, when do we need
amendments to the rule? Does everyone agree--yesterday. I mean,
everybody is shaking their head, yes.
Mr. Wharton, you are not?
Mr. Wharton. Well, I think we need it as soon as possible.
Mr. Shimkus. Not yesterday?
Mr. Wharton. Well, I think, Congressman, the most--they
need to do it as quickly as possible. Most franchisors are
complying with the UFOC now. That is exactly what they do
because it is permitted by the FTC.
Mr. Shimkus. Most of our experience is based on--like Mr.
Rizer's Dairy Queen or McDonald's or that. Yours is different
in that extent. Give us your basic business.
Mr. Wharton. It a stamping business. Basically what
happens, instead of--one major distinction would be instead of
having multiple franchise owners in a particular market area,
we will normally have one franchise owner in a market area. And
that franchise owner has one or two offices at most, because
what we are doing is providing people either temporary staffing
or permanent staffing in a market area.
Mr. Shimkus. It is a little different business model.
Mr. Wharton. It is. That is one of the things you have to
think about. There are all kind of different business models
out there, because if you line it all up with the fast food or
the hospitality industry, it doesn't quite work. But we need it
as quickly as possible. But currently, as a practical matter,
most of the franchisors--I say most; it is probably about 99
percent of the franchisors are using the UFOC, which went
through substantial revision in the mid-1990's to bring it up
to date.
Mr. Shimkus. Chairman, if I can finish the panel then--I
know I am overtime.
Ms. Kezios.
Ms. Kezios. Yesterday would be nice. You should be aware,
though, that there are regional franchisors who choose to sell
just in the States where there are no State regulators reading
documents. Everybody in the franchise industry knows that if
you are starting up and you are young, go to a State where you
don't need to file a document, where nobody is going to read
it. So there is no one looking over anybody's shoulder in those
States.
Mr. Shimkus. That is why the FTC rule is important, to
cover those States where there is no compliance or no
reporting.
Ms. Kezios. That is why the FTC rule is still ineffective
in those States.
The amendments are needed quickly.
Mr. Wieczorek. Yes. The FTC should take action as soon as
possible. Franchisors have been waiting for themselves to get
the new documents prepared and done. But, as Mr. Wharton said,
the UFOC has been in place, the new UFOC has been in place, for
the last 7 or 8 years. That is largely what the new FTC rule
will require. So most franchisors are already doing it. But
there are some additional improvements that the FTC is trying
to do.
Mr. Rizer. It needs to be done as soon as possible. It
would be nice if it was yesterday, but until we have a private
right of action, what good is it to continue to make rules that
aren't enforced or used? It make no sense.
Mr. Shimkus. I will end by saying there is a perfect
example of how business and associations or States, through the
UFOC, respond, how much more rapidly than the Federal
Government if they have had this now for 7 years, and we have
been waiting 5 years for amendments to a rule that we still
don't have a timeline from that is going to probably marry
closely the UFOC. That is just my frustration. And with that I
yield back.
Mr. Stearns. Thank you.
I am going to ask one question, then I think each Member
would like to ask additional questions. If you could have your
way, which two amendments to the FTC rule would you suggest?
And I will just go from right to left with Mr. Cantone. And
would these amendments help with the postsale relationship
problems?
Mr. Cantone. Mr. Chairman, are you talking about amendments
that are not being considered right now?
Mr. Stearns. Yes.
Mr. Cantone. In my personal opinion, Mr. Chairman, there
are two issues that spring to mind, and they may or may not be
able to be addressed in the rule. But one of the issues that we
see time and time again is that franchisors frequently are able
to require that any meaningful dispute resolution be held in
the State of the franchisor, and for small franchisees who
might live States away from the franchisor, it basically stops
that franchisee from going forward and doing any dispute
resolution.
The way that they do that is by requiring arbitration, and
under the Federal Arbitration Act as we view it, the location
for the arbitration can be at the option of the franchisor.
Maryland, for example, has a requirement in our franchise law
that litigation be--about the franchise offering must take
place in Maryland. That is a protection to franchisees to allow
them dispute resolution in Maryland. That only applies to
litigation. Most franchisors require disputes be held through
arbitration, and under the current state of the law, they can
require that that arbitration take place where the franchisor
is located. That, I think, is a really, really big problem. The
franchisees cannot even start to resolve disputes through
litigation or arbitration or whatever. That basically prevents
them from going around and resolving any of the problems they
have.
The other issue that I have is with the fact that the
current--and this might be just a theoretical problem that
might have not have an answer to, is franchising covers such a
huge number of industries, from hotel franchises at one point
to the other end of the spectrum, janitorial franchises, which
really in most cases are the type of franchise directed to
people who have less resources for getting a lawyer or
resources even to review the document. You held up that
document. The most complex franchise disclosure documents and
disclosures are in this industry, and most frequently they
require a very small investment.
That, I think, is an issue that really is a problem in
franchising today as we know it, and I think it is a problem
that needs some resolution. I don't know that the FTC rule as
currently drafted or State laws really address the fact that
there are some real problems out there in one segment of the
industry.
Mr. Stearns. Mr. Wharton.
Mr. Wharton. I guess I would say that the--the proposal to
confirm it to the UFOC is probably the most important piece. I
think that the UFOC is a simplified--somewhat simplified
document. It has all of the information. I think it was during
the mid-1990's when it was revised one--it was done with both
the regulators and the franchisors and the franchisees
participating in the process to ensure that information that
was really important was in that document; and that it was done
further in plain English, that was another change that was made
to it.
While it seems complex, I think that the documents at least
uniformly touch all of the areas that they need to touch, and
that, in itself, if the prospective owner will go through the
document with an advisor, doesn't have to be an attorney, but
some independent advisor that is a professional, to help them
analyze the opportunity, I think that will actually go to help
solving a lot of the postsale problems, because the--if both
sides understand, if both parties to the transaction understand
what is in there and what the issues are going to be and what
the problems are going into the arrangement, then I think that
you solve a lot of the postsale problems. Not all. It is a
long-term relationship. It is like a marriage. I think there
are always going to be disputes. The question is, how do you
work through those. And most franchisors try and work with
their franchise communities to work through those issues.
Ms. Kezios. Other than the two issues that I brought up
already, the problem with the documents is that they are legal
works of art, so it is going to be very difficult to ever
figure out the rules of the game how the documents are written
out, based on how the corporate franchisor lawyers are writing
them. For example, talk about a postsale issue encroachment,
you need to have language as clear as this in the document. You
have no protected area. Your franchisor, without compensation
to you, may place another store in a location that may
completely erode your profitability. That needs to be put in
there. Plain English.
Litigation. The franchisor lawyers, they are hiding the
ball on the litigation. You asked the question, Mr. Rush, what
kind of litigation is required in the document? The litigation
where franchisors are suing the franchisees is not required in
the document now. It should be required. Pending litigation is
not required in the document. So if I am looking at a Dunkin'
Donuts contract offering circular, there may be five pieces of
litigation. They have got 200 lawsuits pending. Wouldn't you
like to know what is going on with those other 200 lawsuits
that the franchisor has filed against franchisees? This is what
I mean by hiding the ball.
These guys know how to write these contracts. There is no
way that you are going to be able to figure out--Mr. and Mrs.
Smith, who are taking their life savings to invest in these
businesses, are not going to be able to figure that out at the
outset. These are not contracts of equal bargaining power.
There is no equal bargaining power in a franchise relationship.
Mr. Wieczorek. I am one of those lawyers that Susan is
referring to. I really don't know how to hide the ball, and our
clients don't try to hide the ball, I can assure you. The most
important thing is--something that Congressman Rush pointed
out--is that these documents are big and intimidating
documents, and we are not--as lawyers drafting them, we are not
trying to draft them so that they are intelligible, we are
drafting them because that is what the rules require us to say.
These are all disclosures and documents that are attached to it
that are required by the law, and we have no way around that.
So I agree that there should be some effort on the part of
government to figure out ways to make the information more
accessible, more readable. And certainly someone should have a
lawyer represent them or a financial advisor represent them
when they are buying a franchise. But even then it would still
be helpful to have the document available on a more accessible
basis.
Mr. Rizer. Well, I am not a lawyer, and so I don't know
what to suggest, other than what I have suggested in my
statement. The private right of action would be very helpful,
and it doesn't matter whether there is State court or Federal
court. If there is no cause for an action, I am not going to
bring one. So that wouldn't be a burden, as you mentioned.
Mr. Stearns. All right. Mr. Rush, any additional?
Mr. Rush. Yes.
Mr. Rizer, I want to continue where you just stopped off.
If you had a private right of action, what would that do for
franchisees that can't--what power or what influence,
bargaining power, would that give to franchisees that they
don't have right now? And let me just also ask, you indicated
that you were advised to sue your franchisor, and you didn't
really want to do that. If you had the right of private action,
just having that there, would that help--you think would help
influence the franchisor to come in and make some kind of
settlement with you earlier rather than having to go through
the process?
Mr. Rizer. Yes. Always having a big stick to wave around is
a wonderful thing. You don't have to use it. It is just that
they know that it is possible. They will be able to come and
talk to you. At the present time there is no reason. As far as
I am understanding, all of this is about the companies,
franchisors, complying with the rules of the FTC. And a private
right of action, if I am harmed because they didn't follow the
rules, if they lied or were deceptive, if they said I could
buy--back in the 1990's it was that they said that I could buy
from anybody, but that wasn't the case, well, to me that is
lying to me.
Mr. Rush. So having a private right of action could kind of
balance the--the territory, give you some kind of common area
of discussion, common influence.
Mr. Rizer. It would give them a reason to come talk.
Ms. Kezios. Private right of action is the only market
force that franchisors will pay attention to. When the
corporate franchisor lawyers worked in the 1970's to hobble the
promulgation of the rule, when the rule's promulgation was
inevitable, they took out the private right of action.
FTC staff are on the record back then--this is from the FTC
staff comments in 1979: The Commission believes that the courts
should and will hold that any person injured by a violation of
the rule has a private right of action against the violators
under the Federal Trade Commission Act as amended in the rule.
Now, that didn't happen, but FTC staff has been on the
record since then saying they fully expected that it would
happen, and it never happened.
Mr. Rush. Mr. Wieczorek.
Mr. Wieczorek. I would like to respond to that. In Mr.
Rizer's case, obviously they brought an action because they had
the right to bring an action. They had a big stick to use. And
right now franchisees do have big sticks to use. They have
lawsuit rights for breach of contract, for common law fraud,
for violation of State law, FTC acts, for violation of State
franchise disclosure laws. I don't think any franchisee
believes that they are hobbled now in terms of having rights to
bring suit.
So no other trade regulation rule that is administered by
the FTC has a private right of action. The courts created--
Congress created the FTC as an expert in the area of the issues
covered by the various rules. So when the FTC decides that a
company violated the FTC rule, they are exercising their expert
objective decisionmaking power that it was a violation. If you
threw it out to the courts, who knows what is going to happen?
The rule would be interpreted 1,000 different ways, and that is
a problem.
Mr. Rush. Let me ask you, Mr. Wieczorek, the IFA, how many
members do you have?
Mr. Wieczorek. IFA has about 1,000 franchisor members,
about 30,000 franchisee members, and about 200 supplier
members.
Mr. Rush. So you represent----
Mr. Wieczorek. Both sides, yes.
Mr. Rush. And, Ms. Kezios, how many members does the AFA
have?
Ms. Kezios. Fifteen thousand.
Mr. Rush. Do you represent any franchisors?
Ms. Kezios. No, we don't I might add that for 40 something
years the IFA didn't represent franchisors either. It was upon
our growth in 1993 that the IFA opened its arms all of a sudden
to franchisees as members, strictly to co-op our efforts.
Mr. Rush. What about suppliers?
Ms. Kezios. No, we don't.
Mr. Stearns. Thank you.
I am going to thank all of you for participating,
sincerely. And we have had a lively discussion. In a democracy
that is what is important. You get your views out. You don't
always agree. But I think this hearing has been very helpful. I
think it is one of the few hearings on franchisors and
franchisees we have had in Congress, so I am pleased to chair
it. I want to thank Mr. Rush for his attendance, and so, again,
thank you all, and the subcommittee is adjourned.
[Whereupon, at 11:55 a.m., the subcommittee was adjourned.]