[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