[Federal Register Volume 60, Number 67 (Friday, April 7, 1995)]
[Proposed Rules]
[Pages 17656-17660]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-8619]



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FEDERAL TRADE COMMISSION

16 CFR Part 436


Request for Comments Concerning Trade Regulation Rule on 
Disclosure Requirements and Prohibitions Concerning Franchising and 
Business Opportunity Ventures

AGENCY: Federal Trade Commission.

ACTION: Request for public comments.

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SUMMARY: The Federal Trade Commission (the ``Commission'') is 
requesting public comments on its Trade Regulation Rule on Disclosure 
Requirements and Prohibitions Concerning Franchising and Business 
Opportunity Ventures (``the Franchise Rule'' or ``the Rule''). The 
Commission is requesting comments about the overall costs and benefits 
of the Rule and its overall regulatory and economic impact as a part of 
its systematic review of all current Commission regulations and guides. 
The Commission also is requesting comment on whether the Rule should be 
modified to: Replace the Rule's disclosure requirements with those set 
forth in the revised Uniform Franchise Offering Circular Guidelines, 
approved by the Commission on December 30, 1993; modify the scope of 
disclosure requirements for business opportunity ventures; clarify the 
applicability of the Rule to trade show promoters; and require the 
disclosure of earnings information. All interested persons are hereby 
given notice of the opportunity to submit written data, views, and 
arguments concerning the Rule.

DATES: Written comments will be accepted on or before August 11, 1995.

ADDRESSES: Comments should be directed to: Secretary, Federal Trade 
Commission, Room H-159, Sixth and Pennsylvania Ave., NW., Washington, 
DC 20580. Comments about the Franchise Rule should be identified as 
``16 CFR Part 436--Comment.''
    Notification of interest in the Public Workshop-Conference should 
be submitted in writing to Myra Howard, Division of Marketing 
Practices, Federal Trade Commission, Washington, DC 20580.

FOR FURTHER INFORMATION CONTACT: Steven Toporoff, (202) 326-3135, or 
Myra Howard, (202) 326-2047, Division of Marketing Practices, Bureau of 
Consumer Protection, Federal Trade Commission, Washington, DC 20580.

SUPPLEMENTARY INFORMATION: The Commission has determined, as part of 
its oversight responsibilities, to review Rules and guides 
periodically. These reviews seek information about the costs and 
benefits of the Commission's Rules and guides and their regulatory and 
economic impact. The information obtained assists the Commission in 
identifying Rules and guides that warrant modification or rescission.
    The Commission is currently seeking comment on several issues 
specific to the Franchise Rule. The Commission recognizes that there 
have been changes in the franchise industry since the Rule was 
promulgated in 1978. Among these changes is the modification of the 
Uniform Franchise Offering Circular (``UFOC'') Guidelines by the North 
American Securities Administrators Association (``NASAA''). In 1986, 
NASAA revised Item 19 of the Guidelines to require franchisors who make 
earnings claims to have a reasonable basis for such claims. On April 
25, 1993, NASAA revised the entire UFOC Guidelines. The Commission 
approved the revised UFOC Guidelines on December 30, 1993. The 
Commission now seeks comment on the desirability of replacing the 
current Rule disclosure requirements with those set forth in the 
revised UFOC Guidelines. The Commission also seeks comment on the 
desirability of modifying the scope of the Rule as it pertains to the 
sale of business opportunities. In addition, the Commission seeks 
comment on whether it should revoke the current conditional exemption 
for trade show promoters and whether it should modify the Rule to add 
specific disclosure requirements or prohibitions concerning trade show 
promoters. Finally, there has been considerable discussion in the 
franchise industry and among franchise regulators about requiring the 
disclosure of earnings information to prospective investors. The 
Commission solicits comment on the desirability of modifying the Rule 
to require the disclosure of earnings information, and if so, what form 
those disclosures should take.
A. Background

    The Franchise Rule was promulgated by the Commission on December 
21, 1978. 43 Fed. Reg. 59,614. The Rule makes it an unfair or deceptive 
act or practice for franchisors and franchise brokers to fail to 
disclose to prospective franchisees specific information about the 
franchisor, franchise business, and terms of the franchise agreement. 
Franchisors and franchise brokers must disclose additional information 
if they make any claim about actual or potential earnings to 
prospective franchisees or to the media. The Rule sets forth both the 
form and content of the required disclosures. Franchisors must provide 
prospective franchisees with the required disclosures before any sale 
is made.

B. Issues for Comment

1. The Revised UFOC

    The Franchise Rule sets forth the content and form of the required 
disclosures. 16 CFR 436.1(a)-(e). In lieu of the Rule's format, the 
Commission has accepted the UFOC Guidelines originally adopted by the 
Midwest Securities Commissioners Association on September 5, 1975. 44 
FR 49,966, 49,970, and as subsequently amended by NASAA on November 27, 
1986. 52 FR 22,686. Most recently, NASAA petitioned the Commission to 
approve new amendments to the UFOC Guidelines, which NASAA adopted on 
April 25, 1993. See Extra Edition, Bus. Fran. Guide (CCH), Rpt. No. 161 
(May 25, 1993). The Commission approved the use of the new UFOC on 
December 30, 1993. 58 FR 69,224. The new amendments are the product of 
a comprehensive revision of the UFOC Guidelines. The Commission is 
concerned about costs and other potential disadvantages to franchisors 
and franchisees that may result from a lack of uniformity between 
federal and state regulations. Accordingly, the Commission solicits 
comments on whether it is desirable to revise the Rule by replacing the 
current Rule disclosure requirements with those set forth in the 
revised UFOC Guidelines.

2. The Application of the Franchise Rule to Business Opportunities

    The Franchise Rule applies to both franchises and business 
opportunities. The Rule currently does not provide a specific 
definition of the term ``business opportunity.'' Rather, the Rule's 
definition of the term ``franchise'' includes some forms of business 
opportunities. Specifically, if the following three conditions are met, 
a business opportunity will be deemed a franchise:
    (A) A person (hereinafter ``franchisee'') offers, sells, or 
distributes to any person other than a ``franchisor'' (as hereinafter 
defined), goods, commodities, or services which are: [[Page 17657]] 
    (1) Supplied by another person (hereinafter ``franchisor''), or
    (2) Supplied by a third person (e.g., a supplier) with whom the 
franchisee is directly or indirectly required to do business by another 
person (hereinafter ``franchisor''); or
    (3) Supplied by a third person (e.g., a supplier) with whom the 
franchisee is directly or indirectly advised to do business by another 
person (hereinafter ``franchisor'') where such third person is 
affiliated with the franchisor; and
    (B) The franchisor:
    (1) Secures for the franchisee retail outlets or accounts for said 
goods, commodities, or services; or
    (2) Secures for the franchisee locations or sites for vending 
machines, rack displays, or any other product sales display used by the 
franchisee in the offering, sale, or distribution of said goods, 
commodities, or services; or
    (3) Provides to the franchisee the services of a person able to 
secure the retail outlets, accounts, sites or locations * * *; and
    (C) The franchisee is required as a condition of obtaining or 
commencing the franchise operation to make a payment or a commitment to 
pay [at least $500 within the first six months of operation] to the 
franchisor, or to a person affiliated with the franchisor.

16 CFR 436.2(a)(1)(ii)(A)-(B) and (a)(2).

    Accordingly, the Commission seeks comment on the desirability of 
modifying the Rule to include a specific definition of the term 
``business opportunity.'' The Commission also seeks comment on whether 
such a definition should include other business opportunity formats 
that are currently not covered by the Rule, such as multi-level 
marketing, seller assisted market plans, work-at-home plans, and 
certain distributorships and licenses.
    The Commission is also concerned that the Rule's disclosure 
requirements may not be well suited to the sale of business 
opportunities and may impose unnecessary costs on both business 
opportunity sellers and buyers. Accordingly, the Commission seeks 
comment on whether to modify the Rule to require different disclosures 
for the sale of business opportunities. Specifically, the Commission 
seeks comment on what disclosures are most relevant to business 
opportunity purchasers. The Commission asks whether certain Rule 
disclosures should be eliminated and if any additional disclosures 
should be required.
3. Trade Show Promoter Liability

    The Franchise Rule applies to franchisors and franchise brokers. 
Franchise brokers are jointly and severally liable for violations of 
the Franchise Rule. 16 CFR 436.1, 436.2(j). In 1981, the Commission 
advised trade show promoters that they would be exempt from Rule 
coverage as brokers if they provided trade show attendees with a 
specific consumer education notice. The notice advises consumers that 
the Commission's Franchise Rule grants them rights to receive certain 
information about a franchise investment prior to signing agreements. 
See 46 FR 52327 (October 27, 1981). The exemption requires trade show 
promoters to give trade show attendees the required notice upon their 
first entry to the show. Trade show promoters who fail to distribute 
the required consumer education notice may be held jointly and 
severally liable for all participating franchisors' Rule violations 
that may occur at the shows.
    Since the Commission issued this conditional exemption in 1981, the 
sale of franchises and business opportunities at trade shows has 
increased significantly. In 1994, the Commission settled charges of 
Rule violations against two trade show promoters who allegedly failed 
to provide the required consumer education notices at their respective 
shows. The Commission solicits comments on the desirability of revoking 
the conditional exemption for trade show promoters. In addition, the 
Commission seeks comment on whether the Rule should be revised to 
provide separate disclosure requirements and prohibitions for trade 
show promoters.

4. Earnings Disclosure Requirements

    Franchisors making claims about actual or potential sales, profits, 
or earnings must provide detailed disclosures mandated by 
Sec. 436.1(b)-(e) of the Rule. Section 436.1(b) enumerates the 
substantiation requirements for claims based on projections or 
forecasts; Sec. 436.1(c), for claims based on actual operating results; 
and Sec. 436.1(e), for claims that appear in media advertising. The 
franchisor must have a ``reasonable basis'' for all such claims; they 
must be ``geographically relevant'' to the potential franchisee's 
market area; and, if they are based on operating results, must be 
prepared in accordance with generally accepted accounting principles.
    The franchisor must also give a separate earnings claim disclosure 
document to any potential investor to whom such a claim is made. The 
earnings claim document must contain a cover page specified by 
Sec. 436.1(d); a full statement of the basis and assumptions for the 
claim; prescribed cautionary language; a notice that substantiating 
material is available for inspection by investors; a disclosure of the 
number and percentage of the franchisor's outlets that have achieved 
the same or better results; and various additional information, 
depending on the type of claim made.
    The Franchise Rule does not mandate the disclosure of actual or 
projected earnings information. The NASAA Franchise Committee and some 
members of its Industry Advisory Committee, however, have proposed that 
franchisors and promoters of business opportunities be required to 
disclose and provide substantiation for some form of earnings 
information to potential investors. They are concerned that, in the 
absence of required earnings disclosures, prospective investors seeking 
information about potential earnings may receive unsubstantiated, 
misleading, deceptive, and possibly false earnings information. The 
Commission shares this concern. Over the past five years, allegations 
of false and deceptive earnings claims have been the most common 
allegation set forth in Commission complaints filed against franchisors 
and business opportunity promoters. Therefore, the Commission seeks 
comments on the desirability of modifying the Rule to include a 
mandatory earnings disclosure. In particular, the Commission seeks 
comments on the specific benefits of such disclosures to prospective 
investors as well as the potential for mandated earnings disclosures to 
mislead prospective investors. In addition, the Commission requests 
comment on potential burdens and compliance costs that such Rule 
modification might impose on prospective franchisees and franchisors. 
The Commission specifically requests commentors to submit statistical 
information, including survey data, or other report materials, in 
support of their comments.

C. Request for Comment

    At this time, the Commission solicits written public comments on 
the following questions:
    (1) Is there a continuing need for the Rule?
    (a) To what extent do franchisors use the Commission's Franchise 
Rule format?
    (b) What benefits has the Rule provided to purchasers of franchises 
and business opportunities?
    (c) Has the Rule imposed costs on purchasers? Explain.
    (2) What changes, if any, should be made to the Rule to increase 
the benefit of the Rule to purchasers? [[Page 17658]] 
    (a) How would these changes affect the costs the Rule imposes on 
firms subject to its requirements?
    (3) What significant burdens or costs has the Rule imposed on firms 
subject to its requirements?
    (a) Has the Rule provided benefits to such firms? Explain.
    (4) What changes, if any, should be made to the Rule to reduce the 
burdens or costs imposed on firms subject to its requirements?
    (a) How would these changes affect the benefits provided by the 
Rule?
    (5) Does the Rule overlap or conflict with other Federal, state, or 
local laws or regulations?
    (6) Since the Rule was issued, what effects, if any, have changes 
in relevant technology, economic conditions, and industry practices had 
on the Rule?

The Revised UFOC Guidelines

    (7) Would it be in the public interest for the Commission to 
establish one national franchise disclosure standard?
    (8) Should the Commission revise the Rule by replacing the Rule's 
required disclosures with those set forth in the revised UFOC 
Guidelines, approved by the Commission on December 31, 1993? Explain.
    (a) What would be the costs and benefits of such a revised Rule on 
sellers of franchises and business opportunities?
    (b) What would be the costs and benefits of such a revised Rule on 
purchasers of franchises and business opportunities?

The Applicability of the Rule to Business Opportunities

    (9) To what extent do business opportunity sellers currently comply 
with the Rule?
    (10) What are the costs and benefits of the Rule to business 
opportunity sellers subject to the Rule's disclosure requirements?
    (11) What are the costs and benefits of the Rule to prospective 
purchasers of business opportunities?
    (12) To what extent do purchasers of business opportunities obtain 
relevant and material information from the required disclosures? 
Explain.
    (13) Should the Commission clarify the Rule by adding a separate 
definition of the term ``business opportunity?'' Explain.
    (a) Should such a definition of ``business opportunity'' be 
expanded beyond the current definition of a ``business opportunity'' 
franchise? Explain.
    (b) Should such a definition include the sale of other business 
arrangements such as multi-level marketing, seller assisted marketing 
plans, work-at-home plans, and certain distributorships and licenses? 
Explain.
    (14) Should the Commission revise the Rule's disclosure 
requirements for sellers of business opportunities? Explain.
    (a) Should the Commission require a different disclosure document 
for business opportunities?
    (b) What information do purchasers of business opportunities need 
that is not currently required by the Rule?
    (c) What disclosures currently required by the Rule should be 
eliminated?
    (15) What would be the costs and benefits to firms that would be 
subject to such revised disclosure requirements?
    (16) What would be the costs and benefits of such revised 
disclosure requirements to purchasers of business opportunities?

Trade Show Promoter Liability

    (17) Should the Commission revoke the current conditional exemption 
to the Rule for trade show promoters? Explain.
    (a) To what extent do consumers purchase franchises or business 
opportunities as a result of attending franchise trade shows?
    (b) To what extent do exhibitors at trade shows violate the Rule in 
their presentations to consumers? What is the nature of any such 
violations?
    (c) What would be the costs and benefits of revoking the 
conditional exemption to the Rule?
    (18) Should the Commission revise the Rule to include separate 
disclosures and prohibitions for trade show promoters? Explain.
    (a) What disclosures should trade show promoters be required to 
make to show attendees?
    (b) What conduct should the Rule prohibit trade show promoters from 
engaging in?
    (c) What would be the costs and benefits of such a revised Rule?

Earnings Information

Background
    (19) To what extent do prospective franchisees want information 
about (a) actual earnings and (b) projected earnings?
    (20) To what extent do prospective franchisees receive pre-sale 
written or oral earnings information?
    (a) To what extent do franchisees receive historical earnings 
information?
    (b) To what extent do franchisees receive earnings projections or 
other earnings claims?
    (c) To what extent do franchisees receive substantiation for such 
earnings information or earnings projections?
    (21) To what extent do franchisors currently provide earnings 
disclosures to prospective franchisees?
    (a) To what extent do franchisors provide historical earnings 
information?
    (b) To what extent do franchisors provide earnings projections or 
other earnings claims?
    (c) To what extent do franchisors substantiate such earnings 
information or earnings projections?
    (22) For those franchisors that do provide earnings information:
    (a) In what industries are these franchisors engaged?
    (b) What is their size (e.g., number of franchisees and gross 
revenues of the franchise system)?
    (c) Does the franchisor use the UFOC or FTC disclosure document 
format?
    (23) To what extent do (a) the Rule requirements and (b) the UFOC 
requirements inhibit franchisors from providing historical earnings 
information or earnings projections to prospective franchisees? 
Explain.
    (24) In the absence of earnings disclosures under the Rule or UFOC, 
is earnings information available to prospective franchisees from other 
sources? Explain.
    (a) What are the costs to prospective franchisees to obtain such 
information?
    (b) To what extent is such information accurate and reliable?
Financial Data Currently Available to Franchisors
    (25) To what extent do franchisors routinely receive financial and/
or other operating performance information from franchisees?
    (a) What types of information do franchisors receive?
    (b) Do franchisees give the information voluntarily or by 
contractual requirements?
    (c) How often do franchisors receive such information?
    (d) How long is such information retained by franchisors?
    (26) Are the financial data currently submitted by franchisees 
sufficient to enable franchisors to provide prospective franchisees 
with an accurate appraisal of the financial risks of investing in a 
franchise? Explain.
    (a) If the data are insufficient to provide such information, what 
additional information would correct the deficiency?
    (b) What would be the additional costs and benefits of obtaining 
and providing this additional information to prospective franchisees? 
[[Page 17659]] 
    (27) To what extent do franchisors conduct periodic audits of 
franchisee financial operations? Explain.
    (28) To what extent do franchisors require franchisees to use 
particular accounting formats? Explain.
Possible Required Earnings Disclosures
    (29) Would it be in the public interest for the Commission to 
establish one national earnings claims disclosure requirement? Explain.
    (30) What types of earnings data, or other measures of franchisee 
operating performance, would be most useful to prospective franchisees 
(e.g., revenues, royalties, net income before income taxes, break-even 
sales volume, time to reach a break-even point, return on investment)? 
Describe.
    (31) Are there industries for which traditional financial measures 
of operating performance are either irrelevant or inadequate to provide 
prospective franchisees with useful earnings information?
    (a) What are these industries?
    (b) What supplemental information could these industry franchisors 
provide to ensure that prospective franchisees receive useful earnings 
information?
    (32) Should the Rule be revised to require franchisors to disclose 
information about franchisee success rates? If so, which measure of 
success (e.g., failures, turnover, or longevity in a franchise system) 
would most help franchisees gauge the financial success of the system? 
Explain.
    (a) How should a franchisee failure be defined? Explain.
    (b) What type of franchisee failure data (number of failures, 
failure rates, or longevity of franchisees who fail) would be most 
useful to prospective franchisees?
    (c) How should franchisee turnover be defined? Explain.
    (d) What type of franchisee turnover data (number of failures, 
terminations, cancellations, or transfers) would be most useful to 
prospective franchisees?
    (e) Should information about franchisee longevity in a franchise 
system, regardless of reasons for departure, be disclosed to 
prospective franchisees? Explain.
    (f) What are the costs and benefits of requiring franchisors to 
disclose information about franchisee failures, turnover, or longevity 
in a franchise system?
    (33) Is it possible to have a uniform earnings disclosure 
requirement for all franchise systems? Explain.
    (34) How can an earnings disclosure requirement be configured to 
assure relevancy to the market location being considered? What types of 
earnings information would be relevant? Explain.
    (35) How can an earnings disclosure requirement be configured to 
reflect differences in the length of franchisees' operating experience? 
Explain.
    (36) How frequently should earnings disclosures be updated?
    (37) How long should prospective franchisees be given to review 
required earnings disclosures before signing a contract? Is the Rule's 
ten-day minimum review period sufficient? Explain.
    (38) If the Commission requires earnings disclosures, should 
franchisors be prohibited from making earnings disclosures other than 
those mandated by the revised Rule? Explain.
    (39) In what ways might a mandatory earnings disclosure be 
misleading or deceptive to prospective franchisees? Explain the 
specific form of earnings disclosure (e.g., gross sales, profit and 
loss statements, average net income) and why it may be misleading or 
deceptive.
Possible Exemptions and Special Circumstances
    (40) What kind of meaningful earnings information can new franchise 
systems provide to prospective franchisees? Explain.
    (a) Should a new franchise system be exempt from an earnings 
disclosure requirement?
    (b) What would be an appropriate exemption period?
    (c) Should a new franchisor be required to provide a negative 
disclosure cautioning prospective franchisees that its franchise system 
has not been in business long enough to provide an accurate earnings 
history?
    (41) What kind of meaningful earnings information can a small 
franchise system provide to prospective franchisees? Explain.
    (a) How should the term ``small franchise system'' be defined?
    (b) Would compliance with an earnings disclosure requirement impose 
significant burdens and costs on small franchise systems?
    (c) Should a small franchise system be exempt from an earnings 
disclosure requirement? If so, should a qualifying small franchise 
system be required to provide a negative disclosure cautioning 
prospective franchisees that its franchise system cannot provide 
accurate and reliable earnings information?
    (42) Should the Commission consider exemptions to an earnings 
disclosure requirement for other circumstances? Explain.
Additional Considerations
    (43) What concerns do franchisors have about being required to 
provide earnings information to prospective franchise purchasers? How 
can the Commission address these concerns?
    (44) If the Commission adopts a mandatory earnings disclosure 
requirement, franchisors might be compelled to collect financial data 
from franchisees. What concerns do franchisees have about: (a) 
revealing financial data to their franchisors; and (b) franchisors' use 
of their financial data to comply with an earnings disclosure 
requirement? How can the Commission address these concerns?
    (45) To what extent do franchisors' contractual agreements with 
franchisees prevent franchisees from disclosing information about their 
own operating performance to prospective franchisees? How should the 
Commission address this concern?

D. Invitation to Comment

    In reviewing the Franchise Rule, Commission staff will consider all 
comments submitted by August 11, 1995. Comments submitted will be 
available for public inspection in accordance with the Freedom of 
Information Act (5 U.S.C. 552) and Commission regulations, on normal 
business days between the hours of 8:30 a.m. and 5 p.m. at the Public 
Reference Section, Room 130, Federal Trade Commission, 6th Street and 
Pennsylvania Avenue, N.W., Washington, D.C. 20580.

E. Public Workshop Conference

    The FTC staff will conduct a Public Workshop Conference to discuss 
written comments received in response to this Request for Comments. The 
purpose of the conference is to afford Commission staff and interested 
parties a further opportunity to openly discuss and explore issues 
raised during the rule review, and, in particular, to examine publicly 
any areas of significant controversy or divergent opinions that are 
raised in the written comments. Commission staff will consider the 
views and suggestions made during the conference, in conjunction with 
the written comments, in formulating its final recommendation to the 
Commission concerning the review of the Franchise Rule.
    Commission staff will select a limited number of parties, from 
among those who submit written comments, to represent the significant 
interests affected by the Rule Review. These parties will participate 
in an open discussion of the issues. It is contemplated that the 
selected parties might ask and answer questions based on their 
respective comments.
    In addition, the conference will be open to the general public. 
Members of [[Page 17660]] the general public who attend the conference 
may have an opportunity to make a brief oral statement presenting their 
views on issues raised in the Rule Review. Oral statements of views by 
members of the general public will be limited to a few minutes in 
length. The time allotted for these statements will be determined on 
the basis of the time allotted for discussion of the issues by the 
selected parties, as well as by the number of persons who wish to make 
statements.
    Written submissions of views, or any other written or visual 
materials, will not be accepted during the conference. The discussion 
will be transcribed and the transcription placed on the public record.
    The conference will be held in the early fall over the course of 
two consecutive days. A forthcoming announcement will provide the exact 
dates and location. Parties interested in participating must notify 
Commission staff by August 11, 1995.

List of Subjects in 16 CFR Part 436

    Advertising, Business and industry, Franchising, Trade practices.

    Authority: 15 U.S.C. 41-58.

    By direction of the Commission.
Donald S. Clark,
Secretary.
[FR Doc. 95-8619 Filed 4-6-95; 8:45 am]
BILLING CODE 6750-01-P