[Federal Register Volume 73, Number 59 (Wednesday, March 26, 2008)]
[Proposed Rules]
[Pages 16110-16138]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-6059]
[[Page 16109]]
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Part II
Federal Trade Commission
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16 CFR Part 37
Business Opportunity Rule; Proposed Rule
Federal Register / Vol. 73, No. 59 / Wednesday, March 26, 2008 /
Proposed Rules
[[Page 16110]]
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FEDERAL TRADE COMMISSION
16 CFR Part 437
RIN 3084-AB04
Business Opportunity Rule
AGENCY: Federal Trade Commission.
ACTION: Revised Notice of Proposed Rulemaking.
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SUMMARY: The Federal Trade Commission (the ``Commission'' or ``FTC'')
is publishing a revised Notice of Proposed Rulemaking to amend Part
437, the trade regulation rule governing sale of business opportunities
that are not covered by the amended Franchise Rule. The revised
proposed Business Opportunity Rule (or ``the Rule'') is based upon the
comments received in response to an Advance Notice of Proposed
Rulemaking (``ANPR''), a Notice of Proposed Rulemaking (``NPRM''), and
other information discussed in this notice. The revised proposed
Business Opportunity Rule would require business opportunity sellers to
furnish prospective purchasers with specific information that is
material to the consumer's decision as to whether to purchase a
business opportunity and which should help the purchaser identify
fraudulent offerings. The proposed rule also would prohibit other acts
or practices that are unfair or deceptive within the meaning of Section
5 of the Federal Trade Commission Act (the ``FTC Act'').
DATES: Written comments must be received on or before May 27, 2008.
Rebuttal comments must be received on or before June 16, 2008.
ADDRESS: Interested parties are invited to submit written comments.
Comments should refer to ``Business Opportunity Rule, R511993'' to
facilitate the organization of comments. A comment filed in paper form
should include this reference both in the text and on the envelope, and
should be mailed or delivered, with two complete copies, to the
following address: Federal Trade Commission/Office of the Secretary,
Room H-135 (Annex S), 600 Pennsylvania Avenue, NW, Washington, DC
20580. Comments containing confidential material, however, must be
filed in paper form, must be clearly labeled ``Confidential,'' and must
comply with Commission Rule 4.9(c).\1\ The FTC is requesting that any
comment filed in paper form be sent by courier or overnight service, if
possible, because U.S. postal mail in the Washington area and at the
Commission is subject to delay due to heightened security precautions.
Moreover, because paper mail in the Washington area and at the Agency
is subject to delay, please consider submitting your comments in
electronic form, as prescribed below.
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\1\ The comment must be accompanied by an explicit request for
confidential treatment, including the factual and legal basis for
the request, and must identify the specific portions of the comment
to be withheld from the public record. The request will be granted
or denied by the Commission's General Counsel, consistent with
applicable law and the public interest. See Commission Rule 4.9(c),
16 CFR 4.9(c).
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Comments filed in electronic form should be submitted by using the
following weblink: https://secure.commentworks.com/ftc-bizopRNPR/ (and
following the instructions on the web-based form). To ensure that the
Commission considers an electronic comment, you must file it on the
web-based form at the weblink https://secure.commentworks.com/ftc-bizopRNPR/. If this notice appears at http://www.regulations.gov, you
may also file an electronic comment through that website. The
Commission will consider all comments that regulations.gov forwards to
it. You may also visit the FTC website at http://www.ftc.gov/opa/index.shtml to read the Revised Notice of Proposed Rulemaking and the
news release describing this proposed Rule.
The FTC Act and other laws the Commission administers permit the
collection of public comments to consider and use in this proceeding as
appropriate. The Commission will consider all timely and responsive
public comments that it receives, whether filed in paper or electronic
form. Comments received will be available to the public on the FTC
website, to the extent practicable, at http://www.ftc.gov. As a matter
of discretion, the FTC makes every effort to remove home contact
information for individuals from the public comments it receives before
placing those comments on the FTC website. More information, including
routine uses permitted by the Privacy Act, may be found in the FTC's
privacy policy, at http://www.ftc.gov/ftc/privacy.htm.
Comments on any proposed filing, recordkeeping, or disclosure
requirements that are subject to paperwork burden review under the
Paperwork Reduction Act should additionally be submitted to: Office of
Information and Regulatory Affairs, Office of Management and Budget,
Attention: Desk Officer for the Federal Trade Commission. Comments
should be submitted via facsimile to (202) 395-6974 because U.S. Postal
Mail is subject to lengthy delays due to heightened security
precautions.
FOR FURTHER INFORMATION CONTACT: Monica Vaca (202) 326-2245, Division
of Marketing Practices, Room 286, Bureau of Consumer Protection,
Federal Trade Commission, 600 Pennsylvania Avenue, NW, Washington, DC
20580.
SUPPLEMENTARY INFORMATION: This Revised Notice of Proposed Rulemaking
seeks comment on a revised proposed Business Opportunity Rule. In
addition to minor wording and punctuation changes to improve clarity,
the revised proposed rule modifies the initial proposal in six
significant ways:
It narrows the scope of the proposed Rule to avoid broadly
sweeping in sellers of multi-level marketing opportunities, while
retaining coverage of those business opportunities sellers historically
covered by the FTC's original Franchise Rule (and by the FTC's interim
Business Opportunity Rule), as well as coverage of sellers of work-at-
home schemes;
It cures a potential overbreadth problem that may have
inadvertently swept in companies using traditional product distribution
arrangements;
It eliminates the previously-proposed requirement that a
covered business opportunity seller disclose the number of cancellation
and refund requests it received;
It eliminates the requirement to disclose litigation
history of certain sales personnel (while retaining the requirement to
disclose litigation history of the seller, its principals, officers,
directors, and sales managers, as well as any individual who occupies a
position or performs a function similar to an officer, director, or
sales manager);
It adds a requirement to include a citation to the Rule in
the title of the required disclosure document; and
It prohibits misrepresenting that the government or any
law forbids providing prospects with a list of prior purchasers of a
business opportunity.
The Commission invites interested parties to submit data, views,
and arguments on the proposed Business Opportunity Rule and,
specifically, on the questions set forth in Section J of this notice.
The comment period will remain open until May 27, 2008. To the extent
practicable, all comments will be available on the public record and
placed on the Commission's website: http://www.ftc.gov/os/publiccomments.htm. After the close of the comment period, the record
will remain open until June 16, 2008, for rebuttal comments. If
necessary, the Commission also will hold hearings with cross-
examination and post-
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hearing rebuttal submissions, as specified in Section 18(c) of the FTC
Act, 15 U.S.C. 57a(c). Parties who request a hearing must file a
comment in response to this notice and a statement explaining why they
believe a hearing is warranted, how they would participate in a
hearing, and a summary of their expected testimony, on or before May
27, 2008. Note that because the NPR has been revised, parties
interested in a hearing must resubmit their request in comments to this
Revised NPR. Parties testifying at a hearing may be subject to cross-
examination. For cross-examination or rebuttal to be permitted,
interested parties must also file a comment and request to cross-
examine or rebut a witness, designating specific facts in dispute and a
summary of their expected testimony, on or before June 16, 2008. In
lieu of a hearing, the Commission will also consider requests to hold
one or more informal public workshop conferences to discuss the issues
raised in this notice and comments.
Section A. Background
The Commission is publishing this Revised Notice of Proposed
Rulemaking pursuant to Section 18 of the FTC Act, 15 U.S.C. 57a et
seq., and Part 1, Subpart B, of the Commission's Rules of Practice. 16
CFR 1.7, and 5 U.S.C. 551 et seq. This authority permits the Commission
to promulgate, modify, and repeal trade regulation rules that define
with specificity acts or practices that are unfair or deceptive in or
affecting commerce within the meaning of Section 5(a)(1) of the FTC
Act. 15 U.S.C. 45(a)(1).
On December 21, 1978, the Commission promulgated a trade regulation
rule entitled ``Disclosure Requirements and Prohibitions Concerning
Franchising and Business Opportunity Ventures'' (the ``Franchise
Rule'') to address deceptive and unfair practices in the sale of
franchises and business opportunity ventures.\2\ Based upon the
original rulemaking record, the Commission found that franchise and
business opportunity fraud was widespread, causing serious economic
harm to consumers. The Commission adopted the Franchise Rule to prevent
fraudulent practices in the sale of franchises and business
opportunities through pre-sale disclosure of specified items of
material information.
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\2\ Statement of Basis and Purpose (``SBP''), 43 FR 59614 (Dec.
21, 1978) (Franchise Rule codified at 16 CFR 436).
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The purpose of the Franchise Rule was not to regulate the
substantive terms of a franchise or business opportunity agreement but
to ensure that sellers disclose material information to prospective
buyers. The Franchise Rule was posited on the notion that a fully
informed consumer can determine whether a particular offering is in his
or her best interest.
As part of the Commission's overall policy of periodic review of
its trade regulation rules, in 1995 the Commission commenced a
regulatory review of the Franchise Rule.\3\ From the outset of that
review proceeding, the predominant theme sounded by commenters and
other participants was that the Rule, insofar as it concerned sales of
business format franchises, should be more closely harmonized with
state franchise regulations--i.e., the Uniform Franchise Offering
Circular (``UFOC'') Guidelines. A corollary theme was that business
opportunity sales should be governed by a separate regulation, in
accordance with the approach followed generally at the state level.
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\3\ Rule Review, 60 FR 17656 (Apr. 7, 1995). References to the
Rule Review comments are cited as: the name of the commenter, RR
comment number (e.g., NASAA, RR 43). References to the Rule Review
workshop conferences are cited as: name of commenter, Sept95 Tr or
March96 Tr, respectively (e.g., D'Imperio, Sept95 Tr, and Ainsely,
March96 Tr). A list of the Rule Review commenters and the
abbreviations used to identify each in this notice is cited in the
Notice of Proposed Rulemaking for the Business Opportunity Rule
(``Business Opportunity Rule NPR''). See 71 FR 19054, 19092-93.
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Moreover, early in the review the issue arose as to whether the
Franchise Rule's extensive disclosure requirements were well-suited to
business opportunity sales and whether the Franchise Rule imposed
unnecessary compliance costs on both business opportunity sellers and
buyers. To ensure that the required disclosures protect prospective
business opportunity purchasers, while minimizing overall compliance
costs, the Commission solicited comment on whether any of the Rule's
disclosures should be eliminated as unnecessary in the business
opportunity context and whether any additional material disclosures
should be required.\4\
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\4\ 60 FR at 17658 (Question 14).
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At the conclusion of the Rule Review, the Commission determined to
retain the Franchise Rule with modifications designed to harmonize it
better with state franchise requirements. At the same time, the
Commission determined to seek additional comment on whether to address
the sale of business opportunities through a separate narrowly tailored
new trade regulation rule.
In 1997, the Commission published an Advance Notice of Proposed
Rulemaking (``ANPR'') in the Federal Register,\5\ seeking further
comment on several proposed Franchise Rule modifications, including the
separation of disclosure requirements for sales of business
opportunities from those for sales of franchises. The Commission also
sought comment on the proper scope of the term ``business
opportunity,''\6\ the types of business opportunities that are known to
engage in deceptive or fraudulent conduct,\7\ and the types of
disclosures that are material to business opportunity purchasers.\8\
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\5\ ANPR, 62 FR 9115 (Feb. 28, 1997). References to the ANPR
comments are cited as: the name of the commenter, ANPR, comment
number (e.g., NASAA, ANPR 120). References to the ANPR workshop
conferences are cited as: name of commenter, ANPR, date Tr (e.g.,
Bundy, ANPR, 6Nov97 Tr). A list of the ANPR commenters and the
abbreviations used to identify each is cited in the NPR. See 71 FR
at 19093-19095.
\6\ 62 FR at 9116-117 and 9121 (Question 12).
\7\ Id. at 9121 (Questions 8-10).
\8\ Id. at 9121 (Questions 15-16).
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After assessing the comments received in response to the ANPR, the
Commission decided to amend the Franchise Rule to harmonize it better
with the UFOC. Accordingly, the Commission published a Franchise Rule
Notice of Proposed Rulemaking (``Franchise Rule NPR''), soliciting
comment on proposed revisions to the Franchise Rule,\9\ and
simultaneously announcing the intention to conduct a separate
rulemaking to address business opportunity sales.\10\ Agreeing with the
overwhelming view of the commenters who discussed this issue during the
Rule Review and in response to the ANPR, the Commission found that
franchises and business opportunities are distinct business
arrangements that require separate disclosure approaches.
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\9\ Franchise Rule NPR, 64 FR 57294 (Oct. 22, 1999).
\10\ Id. at 57296.
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After addressing each of the required stages of rulemaking under
Section 18 of the FTC Act, the Commission announced adoption of an
amended Franchise Rule on January 23, 2007, and published the amended
rule and accompanying Statement of Basis and Purpose on March 30,
2007.\11\ In that Federal Register notice, the Commission also
separated the Franchise Rule into two distinct CFR parts--part 436
governing the sales of business format franchises, and a new part 437,
governing the sales of non-franchise business opportunities. Part
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437 is identical to the original Franchise Rule, with all of the
definitional elements and references regarding business format
franchising deleted.\12\ Part 437 will continue to govern sales of non-
franchise business opportunities, pending completion of the Business
Opportunity rulemaking proceedings advanced in a Notice of Proposed
Rulemaking published April 12, 2006.\13\
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\11\ Amended Franchise Rule Statement of Basis and Purpose
(``Amended Franchise Rule SBP'') 72 FR 15444 (March 30, 2007)
(Amended Franchise Rule codified at 16 CFR 436).
\12\ The interim Business Opportunity Rule differs from the
original Franchise Rule in three respects. First, references to
``franchisor'' and ``franchisee'' in the original Franchise Rule
have been changed to ``business opportunity seller,'' and ``business
opportunity purchaser,'' respectively. Second, the original
definition of ``franchise'' set out at 436(a)(2) has been changed to
``business opportunity,'' and the first part of the original
definition--the ``franchise'' elements--has been deleted; the
definition now focuses on the second part of the original
definition--the business opportunity elements. Third, part 437 sets
forth a new exemption for franchises that comply with or are exempt
from part 436. Amended Franchise Rule SBP, 72 FR at 15444.
\13\ Business Opportunity Rule NPR, 71 FR 19054 (April 12,
2006).
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Section B. The Notice of Proposed Rulemaking
Having determined to create a separate rule for business
opportunities, in 2006 the Commission published in the Federal Register
a Notice of Proposed Rulemaking (``NPR'') on a Business Opportunity
Rule,\14\ which would amend what is now designated as 16 CFR Part 437.
The NPR explained the need for a Business Opportunity Rule separate
from the Franchise Rule, noting particularly that business
opportunities and franchises are distinct business arrangements that
pose very different regulatory challenges. For example, franchises
typically are expensive and involve complex contractual licensing
relationships, while business opportunity sales are often less costly,
involving simple purchase agreements that pose less of a financial risk
for purchasers.
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\14\ Id.
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Yet, the Commission's law enforcement experience in conducting
numerous sweeps of the business opportunity industry demonstrates that
fraud is not only prevalent but persistent, and many comments also
sounded this theme.\15\ Just in the period since 1990, the Commission
has brought some 150 Franchise Rule cases against vending machine, rack
display, and similar opportunities. Since 1995, the Commission has
conducted more than 15 business opportunity sweeps,\16\ many with other
federal and state law enforcement partners, to combat persistent
business opportunity frauds violating the Franchise Rule, such as those
involving the sale of vending machines,\17\ rack displays,\18\ public
telephones,\19\ Internet kiosks,\20\ and 900-number ventures,\21\ among
others. The great majority of these cases alleged Franchise Rule
violations. To attack other forms of business opportunity fraud--
notably, work-at-home and pyramid schemes--the Commission used Section
5 of the FTC Act, because these schemes were not covered by the
original Franchise Rule.\22\
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\15\ E.g., Baer, ANPR 25, at 5; Wieczorek, 21Aug97 Tr at 35;
DSA, id.; Finnigan, id. at 90; Kestenbaum, RR 14, at 3-4; Wieczorek,
RR 23, at 2-3; Lewis, RR 40, Attachment at 3; CA BLS, RR 45, at 5-6;
D'Imperio, Sept95 Tr at 130; Kezios, id. at 365, 631. But see MLMIA,
at 7 & Exhibit A (comment submitted in response to the NPR and its
attached declaration argue that fraud is not widespread in the
business opportunity sector). The exhibit attached to the MLMIA's
comment is belied by the Commission's law enforcement experience,
described above, as well as that of the Department of Justice,
described in its comment. DOJ, at 1.
\16\ E.g., Project Fal$e Hope$ (2006); Project Biz Opp Flop
(2005); Project Busted Opportunity (2002); Project Telesweep (1995);
Project Bizillion$ (1999); Operation Money Pit (1998); Project Vend
Up Broke (1998); Project Trade Name Games (1997), and Operation
Missed Fortune (1996). In addition to joint law enforcement sweeps,
Commission staff has also targeted specific business opportunity
ventures such as envelope stuffing (Operation Pushing the Envelope
2003, medical billing (Operation Dialing for Deception 2002, and
Project Housecall 1997); seminars (Operation Showtime 1998);
Internet-related services (Net Opportunities 1998); vending (Project
Yankee Trader 1997); and 900 numbers (Project Buylines 1996).
\17\ E.g., FTC v. American Entm't Distribs., Inc., No. 04-22431-
CIV-Martinez (S.D. Fla. 2004); FTC v. Pathway Merch., Inc., No. 01-
CIV-8987 (S.D.N.Y. 2001); U.S. v. Photo Vend Int'l, Inc., No. 98-
6935-CIV-Ferguson (S.D. Fla. 1998); FTC v. Hi Tech Mint Sys., Inc.,
No. 98 CIV 5881 (JES) (S.D.N.Y. 1998); FTC v. Claude A. Blanc, Jr.,
No. 2:92-CV-129-WCO (N.D. Ga. 1992). See also FTC News Release: FTC
Announces ``Operation Vend Up Broke'' (Sept. 3, 1998) (available at
http://www.ftc.gov/opa/1998/09/vendup2.htm) (FTC and 10 states
announce 40 enforcement actions against fraudulent vending business
opportunities).
\18\ E.g., U.S. v. Elite Designs, Inc., No. CA 05 058 (D.R.I.
2005); U.S. v. QX Int'l, No. 398-CV-0453-D (N.D. Tex. 1998); FTC v.
Carousel of Toys, No. 97-8587-CIV-Ungaro-Benages (S.D. Fla. 1997);
FTC v. Raymond Urso, No. 97-2680-CIV-Ungaro-Benages (S.D. Fla.
1997); FTC v. Infinity Multimedia, Inc., No. 96-6671-CIV-Gonzalez
(S.D. Fla. 1996); FTC v. O'Rourke, No. 93-6511-CIV-Ferguson (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) (available at http://www.ftc.gov/opa/1997/08/tradenam.htm) (FTC and 8 states file 18 enforcement actions against
sellers of bogus display opportunities that use trademarks of well-
known companies).
\19\ E.g., FTC v. Advanced Pub. Commc'ns Corp., No. 00-00515-
CIV-Ungaro-Benages (S.D. Fla. 2000); FTC v. Ameritel Payphone
Distribs., Inc., No. 00-0514-CIV-Gold (S.D. Fla. 2000); FTC v.
ComTel Commc'ns Global Network, Inc., No. 96-3134-CIV-Highsmith
(S.D. Fla. 1996); FTC v. Intellipay, Inc., No. H92 2325 (S.D. Tex.
1992).
\20\ E.g., FTC v. Bikini Vending Corp., No. CV-S-05-0439-LDG-RJJ
(D. Nev. 2005); FTC v. Network Service Depot, Inc., No. CV-S0-05-
0440-LDG-LRL (D. Nev. 2005); U.S. v. Am. Merch. Tech., No. 05-20443-
CIV-Huck (S.D. Fla. 2005); FTC v. Hart Mktg. Enter. Ltd., Inc., No.
98-222-CIV-T-23 E (M.D. Fla. 1998). See alsoFTC v. FutureNet, Inc.,
No. CV-98-1113 GHK (BQRx) (C.D. Cal. 1998); FTC v. TouchNet, Inc.,
No. C98-0176 (W.D. Wash. 1998).
\21\ E.g., FTC v. Bureau 2000 Int'l, Inc., No. 96-1473-DT-(JR)
(C.D. Cal. 1996); FTC v. Genesis One Corp., No. CV-96-1516-MRP (MCX)
(C.D. Cal. 1996); FTC v. Innovative Telemedia, Inc., No. 96-8140-
CIV-Ferguson (S.D. Fla. 1996); FTC v. Ad-Com Int'l, No. 96-1472 LGB
(VAP) (C.D. Cal. 1996).
\22\ Likewise, they are not covered under 16 CFR Part 437.
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The NPR highlighted features of the original Franchise Rule that
excluded from its coverage certain types of schemes, such as pyramid
schemes and work-at-home schemes.\23\ The Commission noted that many of
these schemes fell outside the ambit of the Franchise Rule because: (1)
the purchase price was less than $500, the minimum payment necessary to
trigger coverage under the original Franchise Rule; (2) required
payments were primarily for inventory, which did not count toward the
$500 monetary threshold; (3) the scheme did not offer location or
account assistance; or (4) the scheme involved the sale of products to
the business opportunity seller rather than to end-users, a further
limitation on coverage under the original Franchise Rule.\24\
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\23\ Two types of work-at-home schemes mentioned in the NPR were
product assembly schemes and envelope-stuffing schemes. 71 FR at
19059-19060.
\24\ The limits on coverage of the original Franchise Rule and
the effects of those limitations are discussed in detail in the NPR.
See 71 FR at 19055.
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To bring the wide array of fraudulent business opportunities within
the scope of the Rule, the NPR proposed an expansive definition of
``business opportunity.'' In addition to those business opportunities
that had been covered by the original Franchise Rule, the Initial
Proposed Business Opportunity Rule (the ``IPBOR'') aimed to cover work-
at-home schemes and pyramid schemes.\25\
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\25\ Id. at 19059.
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To reach these schemes, the NPR proposed a broad definition of
``business opportunity'' that would have included commercial
arrangements where the seller made ``earnings claims'' or offered
``business assistance.''\26\ The Commission recognized that the most
frequent allegation in its law enforcement actions against business
opportunity frauds has been that the seller made false and
unsubstantiated earnings claims. Therefore, the IPBOR incorporated the
broad definition of ``earnings claims'' from the original Franchise
Rule.\27\
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\26\ IPBOR, 437.1(d)(3).
\27\ IPBOR, 437.1(h).
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The IPBOR also defined a new term, ``business assistance,'' in a
broad manner, using five illustrative examples
[[Page 16113]]
of the types of assistance that would trigger coverage.\28\ Among these
examples, the IPBOR included ``buy back'' assistance, which refers to a
seller's offer to buy back products that consumers have assembled at
home.\29\ Another example captured the tracking of payments and
commissions, a type of assistance that pyramid schemes routinely
offer.\30\ Additionally, the definition of ``business assistance''
expressly included assistance in the form of training.\31\
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\28\ IPBOR, 437.1(c).
\29\ IPBOR, 437.1(c)(1)(iii).
\30\ IPBOR, 437.1(c)(1)(iv).
\31\ IBPOR, 437.1(c)(v).
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At the same time, the IPBOR excised two features of the original
Franchise Rule that limited the scope of its coverage: the $500 minimum
payment threshold, and the exemption for purchases of inventory at bona
fide wholesale prices. By eliminating the $500 minimum payment
requirement, the IPBOR would have included within its scope the various
types of fraudulent business opportunity sellers that have evaded
coverage under the disclosure requirements of the Franchise Rule by
pricing their schemes below $500. Envelope stuffing, product assembly,
medical billing schemes, and other schemes frequently are priced below
the monetary threshold of Franchise Rule coverage.\32\ Additionally,
the IPBOR would have ensured coverage of pyramid schemes by eliminating
the inventory exemption.
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\32\ See infra Section D.1.a.1.ii.
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In response to the NPR, the Commission received more than 17,000
comments.\33\ The overwhelming majority of these comments came from the
multilevel marketing\34\ (``MLM'') industry, including industry
representatives, companies, and individual distributors. These
commenters urged the Commission to narrow the scope of the IPBOR, to
implement various safe-harbor provisions, and/or to reduce the required
disclosures. Thousands of comments were form letters\35\ submitted by
participants in various MLM operations, including Quixtar, Shaklee,
PartyLite, Xango, among others.\36\ The Commission also received
approximately 187 comments, primarily from individual consumers or
consumer groups, in favor of the IPBOR.\37\ Only a handful of comments
came in from non-MLM companies and industry groups, expressing various
concerns about obligations that the IPBOR would impose upon them.
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\33\ References to the comments responding to the Business
Opportunity Rule NPR are cited by the name of the commenter and the
page number. Individual commenters are identified by their first and
last names. Companies and organizations are identified by
abbreviated names. A list of companies and organization that are
cited herein and the abbreviations used to identify each is attached
as Attachment A.
\34\ Multi-level marketing is one form of direct selling, and
refers to a business model in which a company distributes products
through a network of distributors who earn income from their own
retail sales of the product and from retail sales made by the
distributors' direct and indirect recruits. Because they earn a
commission from the sales their recruits make, each member in the
MLM network has an incentive to continue recruiting additional sales
representatives into their ``down lines.'' See Peter J. Vander Nat
and William W. Keep, Marketing Fraud: An Approach to Differentiating
Multilevel Marketing from Pyramid Schemes, 21 J. of Pub. Pol'y &
Marketing (Spring 2002), (``Vander Nat and Keep'') at 140.
\35\ Some commenters provided information demonstrating that
certain MLM companies solicited their distributors to submit letters
in their proposed form or template to the FTC. See e.g., James
Kellogg (Quixtar); Smith (Arbonne); Anonymous (PartyLite).
\36\ In addition, the Commission received form letters from
participants in AdvoCare, Tastefully Simple, Nature's Sunshine,
Arbonne, Lia Sophia, Mannatech, Cookie Lee Jewelry, Sunrider, Scent
Station, Neways, Synergy Worldwide, Freelife, Young Living Essential
Oils, and Vemma. In addition, the Commission received thousands of
letters that were individualized but followed a template that
covered the same issues as the form letters.
\37\ Numerous letters came from individuals with negative
experience with various MLMs, including Quixtar, 4Life, Mary Kay,
Arbonne, Liberty League International, Financial Freedom Society,
Herbalife, Xango, Melaleuca, EcoQuest, Pre-Paid Legal, PartyLite,
Shaklee, Vartec/Excel, and Vemma.
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Section C. Scope of the Proposed Rule
The revised proposed Business Opportunity Rule (``RPBOR'') is more
narrowly tailored than the IPBOR. The RPBOR expressly excludes from
coverage training and/or educational organizations that, as the
comments showed, may have been inadvertently covered. In addition, the
revised proposal does not attempt to cover MLMs. Instead, the
Commission will continue to use Section 5, a flexible and effective
weapon, against MLMs that engage in unfair or deceptive practices.
In recognition of the prevalence of fraud in the sale of business
opportunities, including work-at-home and pyramid schemes, the
Commission had designed the IPBOR with an expansive scope in order to
reach various fraudulent practices. While expanding the scope of the
original Franchise Rule's coverage of business opportunities, the IPBOR
greatly reduced the compliance burden that the original Franchise Rule
imposed on business opportunity sellers. The Commission recognized that
the extensive disclosures of the original Franchise Rule would entail
disproportionate compliance costs for comparatively low-cost
transactions involving the sale of business opportunities.\38\
Therefore, in an attempt to strike the proper balance, the Commission
mitigated the compliance burden by including in the IPBOR substantially
simplified and streamlined disclosure requirements.
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\38\ 71 FR at 10057.
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However, the streamlining did not fully achieve the Commission's
purpose. Two key problems emerged with the IPBOR's breadth of coverage.
First, the IPBOR would have unintentionally swept in numerous
commercial arrangements where there is little or no evidence that fraud
is occurring. Second, the IPBOR would have imposed greater burdens on
the MLM industry than other types of business opportunity sellers
without sufficient countervailing benefits to consumers.
1. Traditional Product Distribution Arrangements and Others
Several commenters contended that the IPBOR would have regulated a
wide range of legitimate and traditional product distribution
arrangements that are not associated with the types of fraud that
business opportunity laws are designed to remedy.\39\ As one commenter
described it, the IPBOR would have swept in traditional arrangements
for distribution of ``food and beverages, construction equipment,
manufactured homes, electronic components, computer systems, medical
supplies and equipment, automotive parts, automotive tools and other
tools, petroleum products, industrial chemicals, office supplies and
equipment, and magazines.''\40\ For example, one commenter, a footwear
manufacturer, suggested that the IPBOR could be read to cover the
commenter's product distribution through retail stores simply because
the retailer pays for inventory and the manufacturer provides sales
training to its retail accounts.\41\ Thus, this aspect of the
commenter's operations would meet the definition of ``business
opportunity'' in the IPBOR because: (1) the ``payment''
[[Page 16114]]
prong of the definition did not exempt voluntary purchases of
inventory; and (2) providing retail staff with sales training would
satisfy the ``business assistance'' prong of the definition.\42\
Moreover, review of the comments suggests that even if a company
provides no ``business assistance,'' a product distribution arrangement
still easily could have fallen within the scope of the IPBOR if the
company made some representation about sales or profits sufficient to
constitute an ``earnings claim.''\43\ One trade association notes,
``[a]s a practical matter, suppliers will find it difficult to enter
into a business relationship with a distributor or dealer without at
least discussing possible sales volumes or profit levels.''\44\
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\39\ E.g., IBA, at 1, 5; PMI, at 2; Timberland, at 1;
Sonnenschein, at 1-2 (stating that the rule would cover
``manufacturers, suppliers and other traditional distribution firms
that have relied on the bona fide wholesale price exclusion to avoid
coverage'' under the rule). The Cosmetic, Toiletry and Fragrance
Association posits that the IPBOR would cover the relationship
between a manufacturer and an independent contractor who sells the
product to beauty supply companies, salons, and others. CTFA, at 4.
See also LHD&L at 2 (noting that the IPBOR could cover the
relationship between a manufacturer and a regional distributor of
products).
\40\ IBA, at 5; Timberland, at 1 (noting that numerous
manufacturers structure their retail distribution in this manner).
\41\ Timberland, at 1.
\42\ IPBOR, 437.1(d)(2); IPBOR, 437.1(c)(v).
\43\ IPBOR, 437.1(d)(3)(i).
\44\ IBA, at 4. See also PMI, at 3 n. 1.
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Other commenters argued that the IPBOR would have been broad enough
to cover: bona fide educational programs offered by colleges and
universities;\45\ the sale of certain books by publishers or book
stores;\46\ and even the relationship between newspapers and
independent carriers who distribute the papers to homes and
businesses.\47\ Because application of the IPBOR to these types of
arrangements was unintended, the Commission has narrowed the proposed
definition of the term ``business opportunity,'' to exclude from
coverage distribution arrangements in which the only required payment
is for reasonable amounts of inventory at bona fide wholesale prices.
In addition, the proposed definition of ``business opportunity'' has
been substantially narrowed as explained in Section D, infra.
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\45\ Chadbourne, at 7 - 13 (illustrating the point with numerous
course offering descriptions that could arguably fall within the
definition of ``business opportunity''); Venable, at 3-5 (same).
\46\ Venable, at 2 - 3.
\47\ NAA, at 1-3.
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2. The MLM Industry
The second problem with the breadth of the IPBOR's coverage relates
to the Commission's attempt to reach pyramid schemes with the Business
Opportunity Rule. An overwhelming majority of commenters\48\ argued
that the IPBOR failed to differentiate between unlawful pyramid schemes
and legitimate companies using an MLM business model. These commenters
argued that the requirements of the IPBOR simultaneously would have
been insufficient to curb pyramid fraud\49\ yet devastating to MLM
companies and individual MLM distributors. Criticism was not confined
to industry comments. Two consumer groups also filed comments asserting
that, although MLMs should be covered, the disclosures the Commission
proposed in the IPBOR would be inadequate to remedy deceptive earnings
claims.\50\ On balance, based upon this record and its law enforcement
experience, the Commission does not believe it is practicable or
sufficiently beneficial to consumers to attempt to apply the proposals
advanced in this rulemaking against multi-level marketing companies,
particularly when considering the burdens upon industry. The
Commission, therefore, has determined that at this point, it will
continue to use Section 5 to challenge unfair and deceptive acts or
practices in the MLM industry.
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\48\ Of the more than 17,000 comments that the Commission
received, it is fair to estimate that well over 95% came from
members of the MLM industry expressing opposition to the IPBOR. As
noted above, many of these were form letters.
\49\ DSA, at 21 (positing that compliance with the new mandates
would be ignored by fraudulent pyramid schemes).
\50\ The Consumer Awareness Institute and Pyramid Scheme Alert
each submitted comments and rebuttal comments.
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a. Industry comments
MLM industry representatives, MLM companies, and independent
distributors for those companies submitted numerous comments. The
strongly stated theme common to all these comments was that the low
economic risks of participating in a typical MLM do not justify
imposing burdensome regulations that would threaten to strangle the MLM
industry.
These commenters pointed out that the fees top MLM companies charge
prospective distributors for the right to sell products are low--often
less than $100.\51\ Furthermore, commenters argued, the risk that
consumers will lose money through large purchases of inventory is low.
The Direct Selling Association (``DSA''), a national trade association
of direct selling firms that claims to account for 95% of the
industry's sales in the United States,\52\ asserts that its members
offer a 90% refund on resalable inventory and on other start-up costs,
as well.\53\ Certain MLM companies commented that they do not require
distributors to purchase any inventory in advance of selling it.\54\ As
one commenter put it, purchasing a direct selling opportunity ``is less
complicated and carries less financial risk for a participant than
purchasing a flat-screen TV set.''\55\ Commenters contended that the
low-risk nature of the distributorship is essential to facilitate ease
of entry because the MLM industry relies on part-time and seasonal
distributors.\56\ Furthermore, these commenters argued that there is no
evidence that the MLM industry is permeated with fraud.\57\
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\51\ Shaklee, at 3 ($19.95); Avon, at 10 ($10 or $60); Quixtar,
at 5 ($45); Pampered Chef, at 2 ($90); Mary Kay, at 3 ($100).
\52\ DSA, at 4. According to the DSA, 84% of direct selling
firms use some form of multilevel compensation. DSA, at 9, 13
(defining direct selling as ``the sale of a consumer product or
service, in a face-to-face manner, away from a fixed retail
location'').
\53\ DSA, at 24 n. 45 (describing the Code of Ethics that
members must follow). See also, e.g., Shaklee, at 6 (stating it has
a 90% buy back requirement for its products and start-up kit
purchased within the last two years); Quixtar at 3.
\54\ Primerica Rebuttal, at 6; Avon, at 4; Quixtar, at 5; Mary
Kay, at 4.
\55\ Primerica Rebuttal, at 17.
\56\ E.g., Mary Kay, at 4 (estimating that 80% of its sales
force members are part-time); Avon, at 3 (``With its low cost / low
risk design, many Representatives take advantage of its ease of
entry and exit to come and go as their needs / goals change.'');
CTFA, at 2.
\57\ E.g., SIA, at 5; Primerica, at 34; DSA, at 18-20.
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The MLM industry commenters also sharply criticized each of the
primary requirements of the IPBOR. They argued that, balanced against
the low risk of financial loss, it would be excessively burdensome to
mandate a seven-day waiting period and the various disclosure and
recordkeeping obligations. The seven-day waiting period would require
sellers to wait seven days after presenting disclosure documents to the
prospective purchaser before collecting any money or obtaining an
executed contract.\58\ The provision is designed to allow prospective
purchasers the opportunity to review required disclosures thoroughly or
to speak with an advisor. The proposed seven-day waiting period drew
intense criticism from industry groups, and was characterized as
``regulatory overkill'' by Primerica Financial Services, Inc.\59\
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\58\ IPBOR, 437.2.
\59\ Primerica Rebuttal, at 16. See also MLM DRA, at 5 (stating
that ``the majority of MLM distributors are very small mom and pop
businesses'' and that ``this burden would very likely ruin their
business.''). United States Congressman Tom Cole also submitted a
comment expressing the opinion that the seven-day waiting period is
inappropriate for business opportunity sales costing less than $500.
Cole, at 1.
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MLM industry commenters argued that the waiting period would
undercut the basic MLM business model, characterized by minimal risk of
financial loss and maximum ease of entry. The DSA submitted a survey
showing that the level of interest in becoming a direct salesperson
drops at least 33% and as much as 57% when a waiting period is
imposed.\60\ Commenters opined that the waiting
[[Page 16115]]
period would make entry into this business much harder; moreover, some
commenters stated that the waiting period would significantly burden
recruiting because multiple visits would be necessary for each
potential recruit.\61\
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\60\ DSA, at 24.
\61\ DSA, at 25-26 (positing that three visits would be required
to sign up a prospective participant); Shaklee, at 6 (stating that a
waiting period would be ``as though regulators had painted a big `X'
on the backs of direct selling companies, warning consumers `not to
go there.'''); Avon, at 14.
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Industry commenters also contended that the various disclosure
obligations of the IPBOR are ill-suited to the MLM business model. For
example, industry commenters assert that an MLM's list of distributors
is proprietary information\62\ that is kept strictly confidential
because distributors necessarily compete with each other to recruit
additional distributors into their ``down lines.''\63\ The IPBOR would
have required an MLM distributor to provide to every potential recruit
a disclosure document that includes a list of other distributors as
references.\64\ As one commenter put it, furnishing a list of
distributors to every individual who inquires about an MLM
distributorship, ``would be like requiring a salesman to introduce his
customer to ten competing salesmen and then wait seven days before
attempting to close a sale.''\65\ The Commission notes that another
characteristic of the MLM model may undermine the utility of the list
of references that the IPBOR would have required MLMs to disclose.
Specifically, a previous purchaser on the reference list likely would
stand to receive a financial benefit if a prospect who contacts them
were successfully recruited by that previous purchaser. Under these
circumstances, information from such a reference might not be the most
reliable basis for the prospect's purchasing decision.
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\62\ Shaklee, at 7 (``a company's distributor and customer lists
are its most important and confidential information which
competitors must be kept from accessing.''); DSA, at 30 (stating
that the list of sellers has been kept confidential even from the
IRS); Avon, at 16-17;
\63\ Avon, at 16-17 (stating that direct selling companies
compete for same recruits); DSA, at 30-31.
\64\ IPBOR, 437.3(a)(6).
\65\ Quixtar, at 31-32.
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Other disclosure obligations of the IPBOR, industry commenters
contended, ``will paint all direct selling companies in a falsely
negative light.''\66\ For example, according to one commenter, the
proposed obligation to disclose legal actions\67\ would cast successful
and long-established companies in a worse light than a fly-by-night
fraudulent business opportunity promoter ``simply because bigger
companies with more sales representatives and more years of operation
are likely to get involved in a larger number of cases.''\68\ Some
commenters pointed out that as publicly-traded companies, information
about their legal actions is already publicly available.\69\
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\66\ Pre-Paid Legal, at 8.
\67\ IPBOR, 437.3(a)(3).
\68\ Quixtar, at 34. See also SPC, at 3 (stating that it is a
subsidiary of Time, Inc., and the litigation disclosure of affiliate
companies would encompass all of Time Warner, which includes
hundreds of companies).
\69\ Avon, at 10, 15; Pre-Paid Legal, at 14.
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Similarly, according to these commenters, the obligation to
disclose refund requests and cancellations\70\ would penalize MLM
industry members who deliberately structure their business model to
facilitate ease of entry by offering refunds. Because companies with
liberal refund policies are more likely to have refund requests than
those offering no refunds, disclosure of refund requests could mislead
consumers into thinking that the company offering liberal refunds is
less reputable than the company offering no refunds.\71\ The rule would
create a perverse incentive to discontinue refund policies.\72\
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\70\ IPBOR, Section 437.3(a)(5).
\71\ E.g., Pre-Paid Legal at 15-16; DSA, at 29 (stating that
because individuals enter and exit direct selling each year to meet
short term goals, the number of cancellation requests is likely to
be artificially high and misleading). See also Quixtar, at 39
(asserting that because individuals join and leave for various
personal reasons, information on cancellations would be ``of little,
if any, benefit''); PANM, at 3 (stating that reporting cancellations
and refunds serves no purpose at all where the fee is nominal).
\72\ MLMIA, at 51-52, Pre-Paid Legal, at 16; Herbalife, at 10.
See also Carico, at 1 (stating that because dishonest companies
would not honor an agreement to make refunds, the IPBOR would only
have a negative effect on legitimate companies).
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Some industry commenters contended that the IPBOR's earnings claim
disclosure requirement\73\ would itself be misleading or incomplete.
While some commenters stated they already make an earnings disclosure,
they opposed the IPBOR's provisions for a variety of reasons.\74\ For
example, some industry commenters argued that only the earnings of so-
called ``active'' distributors should be considered because many
individuals use their distributorship as a ``buyers club'' and are only
interested in purchasing goods at a wholesale price for their own use,
not for resale.\75\ Commenters argued that those who use the
distributorship in this way do not expect to earn money, and so the
earnings of these inactive distributors should not be counted.\76\
Further, one commenter stated that a disclosure of average earnings may
unfairly suggest that distributors achieve low earnings when, in fact,
those earnings are substantial given the amount of time spent
selling.\77\
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\73\ IPBOR, 437.3(a) and 437.4.
\74\ E.g., Quixtar, at 25-26 (proposing an earnings disclosure
that would include only ``active'' distributor earnings and would
allow the company to ``infer a reasonable level of `retail'
profit''); Melaleuca, at 9-10 (stating that it publishes income
statistics but opposing a federally mandated disclosure); FreeLife,
at 4 (preferring disclaimers to the IPBOR's requirements).
\75\ E.g., Shaklee, at 3 (stating that 85% of individuals who
sign up with Shaklee do so as ``wholesale buyers'' rather than
distributors); Quixtar, at 8; Herbalife, at 2.
\76\ E.g., Quixtar, at 25 & n. 30; Primerica Rebuttal, at 34.
\77\ Avon, at 19. See also DSA, at 33 (questioning the relevance
of earnings statistics to an individual who enters as discount buyer
or for short term supplemental income).
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Furthermore, many industry commenters argued that the IBPOR's
required earnings disclosure would be far too complicated because it
would require a disclosure of the material characteristics of
purchasers who earned the claimed income.\78\ As such, some industry
commenters expressed concern that the proposed earnings disclosure
would unnecessarily complicate a simple and low-risk transaction.\79\
Furthermore, other commenters pointed out that it would be extremely
burdensome for legitimate businesses that attempted to comply,\80\ but
it would not be helpful to consumers in evaluating the opportunity or
in distinguishing fraudulent claims.\81\ One commenter went further,
stating that: ``the required disclosures do not address the crucial
distinction between pyramids and legitimate multi-level marketing--
i.e., in pyramids, compensation is based on recruitment, rather than
sales for consumption.''\82\
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\78\ The IPBOR would require disclosure of ``any characteristics
of the purchasers who achieved at least the represented level of
earnings, such as their location, that may differ materially from
the characteristics of the prospective purchasers being offered the
business opportunity.'' IPBOR, 437.4(a)(4)(vi).
\79\ Avon, at 18; Quixtar, at 21 (stating that the goal should
not be ``to provide a maze of intricate calculations and disclosures
but to instead put across the simple point that most participants in
the business opportunity earn modest incomes'').
\80\ E.g., DSA, at 33; HIG, at 3; Pre-Paid Legal, at 10. Some
commenters contend that it would be impossible to comply with this
requirement. Shaklee, at 10; Xango, at 6; Vector, at 3.
\81\ E.g., DSA, at 33; Xango, at 6; Mary Kay, at 10; Synergy, at
2. See also Xango, at 6 (``[s]uch complicated compilations will only
serve to confuse prospective purchasers''); Symmetry, at 2.
\82\ Primerica, at 26.
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Finally, echoing the concerns raised above, industry commenters
uniformly asserted that the cost of compliance with the IPBOR would be
extremely high, much higher than the Commission
[[Page 16116]]
estimated.\83\ The costs of complying would arise, first, from the
burden of developing, providing, and keeping records of the proposed
disclosures, and second, from the impaired ability to recruit. With
regard to the first point, industry commenters contended that the
burden of making the proposed disclosures would fall disproportionately
on established, legitimate businesses.\84\ For example, the single page
disclosure would be simple for a new--possibly fraudulent--company that
has no litigation history and fewer than 10 references.\85\ For long-
established MLMs, however, the costs would be quite high: having polled
its members on this issue, the DSA states that the median total
compliance cost for a small firm would be approximately $130,000
annually, and more than $567,000 annually for a large firm.\86\ DSA
further estimates that because about 5 million people are recruited
into direct selling each year, the paperwork burden would include
distributing over 750 million pages of disclosure documents
annually.\87\ Furthermore, according to the DSA, the IPBOR's
requirement to retain documents for three years would require 2.25
billion pieces of paper to be generated and warehoused.\88\
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\83\ Mary Kay, at 9 (estimating that the record keeping
requirement would cost ``between $300,000 and $500,000 per year in
additional expenses, software and training'').
\84\ Primerica, at 15-16.
\85\ Id.
\86\ DSA, at 21-22 (stating that 26 firms responded to its July
2006 survey on compliance costs). See also Shaklee, at 9 (estimating
that the cost of compliance would likely exceed $100 million for the
industry); MLMIA, at 12 (estimating that cost of compliance for each
MLM distributor would be between $25,000 to $45,000 for the first
year and $10,000 to $20,000 per year thereafter).
\87\ Id. at 21 (reporting that respondents estimate disclosing
15 pages of documents under the IPBOR). See also Vector, at 3
(estimating that the proposed disclosure would require Vector to
provide over 100 million pieces of paper annually to potential
recruits).
\88\ Id. at 21. See also Melaleuca, at 5 - 6 (estimating that
Melaleuca would need to store 1.8 million disclosure documents over
a rolling three-year period).
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Second, and apart from the direct cost of complying, industry
commenters contend that the IPBOR's requirements would impose high
costs because it would significantly impair the ability to recruit.\89\
According to Primerica, ``[b]ased on a conservative estimate that the
Proposed Rule would reduce Primerica's recruiting by 25 percent,
Primerica projected an economic loss of $1 billion for Primerica alone
over the next ten years if the [IPBOR were] promulgated.''\90\ The cost
of impaired recruiting, some commenters argued, would be borne by the
millions of individual MLM distributors who would find their home
businesses adversely affected.\91\ Indeed, the MLM Distributors Rights
Association (``DRA'') warned that the IPBOR would put ``millions out of
business,'' and concluded with a plea to ``come up with a new rule that
will protect without damaging the little guy in America trying to make
a living.''\92\ Numerous letters submitted by individual MLM
participants echo this theme, as well.\93\
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\89\ ``If a new application, disclosure document and seven-day
waiting period were required for a Member to become a Distributor,
the number of Members who choose to build a small home-based
business would dramatically decline.'' Shaklee, at 6 (stating that
recruitment dropped when Shaklee introduced two applications instead
of one).
\90\ Primerica Rebuttal, at 11 (emphasis in original).
\91\ MLM DRA, at 2, 5 (estimating that there are between 13
million and 15 million MLM distributors in the United States);
Babener, at 3 (the IPBOR would cripple ``the livelihoods of 14
million Americans that look to direct selling to help support their
families'').
\92\ DRA, at 2, 7. The DRA demands that the Commission drop the
IPBOR in its entirety. DRA, at 2.
\93\ E.g., Tina Bailey, at 1 (``This bill would kill my business
and I would loose (sic) my ability to be a stay at home mom with an
income.''); Eric Gang, at 1 (``If adopted, the Rule would destroy my
small business that I have worked so hard to develop.''); Anne
Trevaskis, at 1 (``As a person with a disability, unable to go out
to work, if [the IPBOR] is adopted, I will be prevented, continuing
as an independent distributor''); Marian Warshauer, at 1 (``Please
don't penalize and ruin and honest earning opportunity for tens of
thousands of people with legitimate companies); Noelle Marino, at 1
(``I'm very concerned about [the IPBOR], because I believe it will
jeopardize my business.'').
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b. Consumer group comments
The Commission received comments from two consumer groups, the
Consumer Awareness Institute (``CAI'') and Pyramid Scheme Alert
(``PSA''),\94\ a few other consumer advocates,\95\ individuals who
regret becoming involved in MLMs,\96\ and other individual MLM
participants in favor of a Business Opportunity Rule that would cover
MLMs.\97\ Consumer advocates contend that the MLM industry is comprised
primarily of pyramid scheme operators masquerading as legitimate
companies.\98\ While commenters lauded the Commission's efforts to
impose a business opportunity rule that would cover MLM firms, they
argued that the rule's earnings disclosure requirements were
insufficient to expose a fraudulent MLM company as a pyramid
scheme.\99\ CAI expressly recommended a different disclosure for MLM
companies than for all other forms of business opportunities.\100\
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\94\ CAI and PSA each submitted comments with numerous reports
attached. Citations to their comments will specifically note the
submitting entity and the name of the report.
\95\ See Eric Scheibeler (author of Merchants of Deception, a
book ostensibly warning the public about Quixtar); Bruce Craig
(former Assistant Attorney General for the State of Wisconsin);
Douglas Brooks (law practitioner who has represented class actions
against MLM companies).
\96\ E.g., Katy Li (``If I had been given basic statistics about
the company I never would have joined''); Marshelle Hinojosa
(``Please pass the BUSINESS OPPORTUNITY LAW and stop these pyramid
schemes!''); Valerie Andersen (``Words cannot express the
humiliation, financial loss and lost respect and trust from friends
and family members ... whom [sic] were persuaded by me because they
trusted me ... to join the MLM ...''); J Padgett (describing his
wife's involvement in an MLM); Robin Smith (stating that she would
not have joined an MLM if she had known the background of the
principals); David McHenry (``Make these MLMs legally responsible
for their claims with documentation that is accurate from the
beginning.''); James Kenny; Charles Wagner; Brian Wess; Kelly
Boucher, Rebuttal; Carol Franklin, Rebuttal.
\97\ E.g., Barbara Avery (``Direct selling or mlm CAN be a good
program if done with honesty and integrity- enacting laws to protect
the consumer would be a welcome change!!''); Kristine Keesler (``I
think this new legislation would be very beneficial. If I had seven
days to consider my decision and 10 references I would not have
jumped into the ... business so quickly.'').
\98\ CAI, at 2 (``I can certify that MLM (sic) are not direct
selling programs, but chain selling programs''); CAI Rebuttal of DSA
Comments, at 3 (``The Direct Selling Association (DSA), recently
taken over by chain sellers now promotes chain selling (pyramid
marketing) - even more than legitimate direct selling''). See also
Brooks, at 2 (``In my opinion, most MLM firms operate in a deceptive
or fraudulent manner'').
\99\ CAI, at 3; PSA, at 2. See also Douglas Brooks, at 3
(stating that disclosures will not prevent consumer injury caused by
pyramid schemes).
\100\ CAI, at 6.
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According to these consumer groups, virtually all MLMs are pyramid
schemes that enrich those at the top through the endless recruitment of
new participants.\101\ These commenters contended that the purported
sale of products to end users (i.e., typical customers) is just a
mirage, because the MLM sales force seldom engages in retail
selling.\102\
---------------------------------------------------------------------------
\101\ CAI, at 2 (``out of hundreds of MLM programs we have
evaluated, no more than a (sic) three of them could qualify as
legitimate retail-based programs.''). See also PSA, at 1.
\102\ PSA, The Myth of Income Opportunity in Multi-Level
Marketing, at 4.
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Further, according to these commenters, MLMs deceptively market
distributorships as a low-risk opportunity with high earnings
potential. In fact, the cost of participating in an MLM can be quite
high, including not only the registration fees, but also the cost of
product purchases, training and seminars, and other features purported
to enhance a recruit's performance in an MLM.\103\ The typical
earnings, by contrast, are extremely small and cannot be
[[Page 16117]]
considered anything but a net loss when business expenses are
considered.\104\ In fact, these commenters contended, more than 99% of
individuals who participate in MLMs lose money.\105\
---------------------------------------------------------------------------
\103\ PSA, The Myth of Income Opportunity in Multi-Level
Marketing, at 4 (pointing to Amway/Quixtar's sale of books, tapes
and seminar registrations to new recruits); Douglas Brooks, at 4, 5;
Scott Johnson, at 1.
\104\ PSA, The Myth of Income Opportunity in Multi-Level
Marketing, at 3 (stating that 99% of all sales representatives in
the sample of companies analyzed earned less than $14 per week, a
figure that does not count any business expenses, such as inventory
purchases).
\105\ PSA, at 2; CAI, The 5 Red Flags, at 15-16. One commenter,
noting that some MLMs require no advance purchases of inventory,
strongly disagreed with this conclusion: ``The facts in the record
provide no basis for deducting assumed `costs' from the available
income estimates and jump to the conclusion that participants
actually lose money . ... It is simply not possible that agents are
required to pay more money to Primerica than they receive in
commissions, because there is no requirement that they buy anything
from Primerica.'' Primerica Rebuttal at 6 (emphasis in original).
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These consumer groups recommended implementing a number of changes
to the disclosure requirements in the IPBOR. To begin with, the IPBOR
would have required business opportunity sellers to state whether they
make any earnings claim, and if they do, to have written substantiation
for the claim.\106\ PSA argued that MLMs are presented to consumers as
income opportunities, and therefore, should not be allowed the option
of asserting that they make no earnings claim.\107\ With regard to the
earnings disclosure itself, they recommended two changes to the IPBOR.
First, they recommended that the earnings disclosure state the average
retail-based income that participants achieve.\108\ They argued that,
by focusing on dollars earned from retail sales, the disclosure
document would highlight the key feature that distinguishes a
legitimate company from a pyramid scheme--the sale of products to end
users.\109\
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\106\ 437.3(a)(2) & 437.4(a)(2).
\107\ PSA at 2. Several individuals filed form comments, with
small variations, making this point as well. E.g., Jean Smith;
Douglas Konkol; Harold Ducre; Rachel Quill; N Gursahani; Petteri
Haipola; Bradford Chase; Curtis Marburger; Joel Rolfe; Marshall
Massengill; Marcus Batte. See also CAI, at 6 (asserting that if MLMs
present themselves as offering an ``income opportunity,'' they
should have to disclose earnings).
\108\ PSA, at 2.
\109\ PSA, at 2. CAI, Red Flags at 5 (acknowledging that an MLM
may be legitimate if it allows a person to earn a significant income
from retailing products to end users).
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Second, these commenters asserted that the earnings disclosure
should state not only the revenue paid to participants, but also should
reveal the payments by participants for products and services.\110\ CAI
argued that product purchases--necessary to advance in the MLM
hierarchy--are often a major element of the overall investment in an
MLM; typically, the initial registration fee is nominal, and is just
the beginning of the total investment.\111\ PSA also argued that the
earnings disclosures that some MLMs make are deceptive because they
fail to include the money participants pay out to the MLM.\112\ In
addition, according to PSA, MLMs routinely include only the income of
``active'' participants in their averages, and thus conceal ongoing and
mounting losses of new investors.\113\
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\110\ CAI, at 7; PSA, at 2.
\111\ CAI, Red Flags, at 10.
\112\ PSA, at 2.
\113\ PSA, The Myth of Income Opportunity in Multi-Level
Marketing, at 3.
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Regarding the other provisions of the IPBOR, CAI supported the
requirement of disclosing refund history, but noted that it is not
particularly useful in the MLM context, inasmuch as ``[i]t is extremely
rare for MLM victims to recognize the fraud in an MLM program without
intensive de-programming by a knowledgeable consumer advocate.''\114\
CAI also recommended that the ten referrals to prior purchasers should
include at least five ex-participants in the business,\115\ and that
there should be a three-day waiting period that includes a
recommendation to search the internet for information about the
company.\116\
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\114\ CAI, Red Flags at 11; CAI, at 7.
\115\ CAI, at 7.
\116\ CAI, at 6.
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3. Analysis
Section 18(d)(2)(B) of the FTC Act, 15 U.S.C. 57a(d)(2)(B), states
that ``[a] substantive amendment to, or repeal of, a rule promulgated
under subsection (a)(1)(B) shall be prescribed, and subject to judicial
review, in the same manner as a rule prescribed under such
subsection.'' The standard for amending or repealing a section 18 rule
is identical to that for promulgating a trade regulation rule pursuant
to section 18.
When deciding whether to amend a rule, the Commission engages in a
multi-step inquiry. Initially, the Commission requires evidence that an
existing act or practice is legally unfair or deceptive. The Commission
then requires affirmative answers, based upon the preponderance of
reliable evidence, to the following four questions:
(1) Is the act or practice prevalent?\117\
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\117\See 15 U.S.C. Section 57a(b)(3) (stating that prevalence
may be established if information available to the Commission
indicates a widespread pattern of unfair or deceptive acts or
practices).
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(2) Does a significant harm exist?
(3) Would the rule provisions under consideration reduce that harm?
and
(4) Will the benefits of the rule exceed its costs?
See Credit Practices Rule, 49 FR 7740, 7742 (Mar. 1, 1984).\118\
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\118\See also 15 U.S.C. Section 57a(d)(1)(A)--(C) (requiring in
the Statement of Basis and Purpose accompanying the rule a statement
as to prevalence, the manner in which the acts or practices are
unfair or deceptive, and the economic effect of the rule); Federal
Trade Commission Organization, Procedures and Rules of Practice, 16
CFR 1.14(a) (i)-(iv).
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The discussion below addresses, first, the question of whether
there are widespread unfair or deceptive acts or practices that cause
consumer harm. Second, the discussion reviews the various proposals for
reducing consumer harm and the adequacy of case-by-case law enforcement
under sections 5 and 13(b) of the FTC Act to address existing problems.
To summarize, while there is a significant concern that some pyramid
schemes masquerade as legitimate MLMs, assessing the incidence of such
practices is difficult. In any event, commenters broadly concur that
the IPBOR would not help consumers make an informed decision about the
risks of joining a particular MLM. Further, the comments do not provide
sufficient information about how to tailor the proposed rule so that
disclosures assist in the purchase decision in a manner that is likely
to reduce consumer harm. Moreover, it is appears that the burden of
complying with the IBPOR would be costly to legitimate companies using
the MLM business model without the promise of sufficient offsetting
benefits to prospective purchasers of MLM distributorships.
a. Prevalence of deceptive practices causing significant consumer harm
In considering whether to impose an industry-wide rule covering
MLMs, the threshold inquiry is identifying the unfair or deceptive
practices at issue. If such practices exist, the Commission evaluates
whether such practices are prevalent and cause significant consumer
harm. While these are separate areas of consideration, these inquiries
overlap and are discussed together to avoid unnecessary redundancy.
There are two related but distinct allegations of deceptive
practices regarding MLM companies. The debate about the legitimacy of
MLM companies typically centers on whether an MLM operates as a
pyramid. By their very nature, pyramid schemes are deceptive and
violate the FTC Act. Equally serious, however, is the question of
whether an MLM is engaged in making false earnings claims. These
allegations are clearly related in that any claim that the average
participant in a pyramid
[[Page 16118]]
scheme will make money is necessarily false. But even if an MLM is not
operating as a pyramid scheme, it violates the FTC Act if it makes
false earnings projections to consumers.
The comments received about the legitimacy of MLMs, discussed
above, demonstrate sharply divergent points of view. The record in this
proceeding to date is largely comprised of thousands of letters from
consumers who operate as MLM distributors.\119\ Many of these
commenters extolled the benefits of the products they sell and
overwhelmingly urged the Commission not to impose a rule that would
hamper their ability to run their small businesses.\120\ Organizations
representing distributors also voiced strong opposition to the
IPBOR.\121\ In addition, the National Association of Consumer Agency
Administrators (``NACAA''), after canvassing its members nationwide,
stated that they ``reported there was no appreciable number of
complaints filed against direct sellers that are member companies of
the Direct Selling Association.''\122\ One comment presented a survey
finding that an ``average'' distributor earns $418 per month,\123\ and
DSA presented another survey\124\ finding that 85% of direct sellers
say that direct selling meets or exceeds their expectations as a good
way to supplement their income.\125\ Given the overwhelming number of
comments from consumers who operate as MLM distributors and from
organizations representing such distributors, the Commission does not
dispute the proposition that MLM companies can operate legitimately.
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\119\ In response to the NPR, the Commission received comments
from approximately 16,700 individual MLM distributors. While several
thousands of these were form letters, thousands more included
individual recitations of positive personal experiences with the MLM
distributorships.
\120\E.g., Tom Hadley, at 1 (pastor stating that he uses the
income he receives from his XanGo distributorship to pay his
childrens' college expenses); Gary Minor, at 1 (distributor of Young
Living Essential Oils states he believes the product is exceptional
and he makes money from selling product); Kelly Radke, at 1
(Tastefully Simple distributor stating that direct selling is a way
for moms to stay home with their kids, pay off bills, and even save
for vacations and retirement).
\121\ The Commission received comment from the World Association
of Persons with disAbilities, Inc., the MLM Distributor Rights
Association, and the Professional Association for Network Marketing,
expressing opposition to the IPBOR.
\122\ NACAA, at 1 (stating that ``NACAA currently represents
more than 160 government agencies and 50 corporate consumer offices
in the United States and abroad.''). The Chamber of Commerce of the
United States of America also filed a comment stating that in
``coordination with key industry leaders,'' it has concluded that
the IPBOR would ``impose a tremendous burden on legitimate
businesses with little benefit to consumers.'' CC USA, at 1.
Although it does not expressly mention the DSA, the Commission
believes that the CC USA is referring to the direct selling
industry. Similarly, the National Black Chamber of Commerce filed a
comment urging the Commission to tailor the IPBOR more narrowly
because of the impact on direct selling companies. NBCC at 1-2.
\123\ MLMIA, Appendix A at 13 (Coughlan and Grayson, Network
Marketing Organizations: Compensation Plans, Retail Network Growth,
and Profitability, 15 International Journal of Research in Marketing
401 (1998)).
\124\ DSA Rebuttal, at 3.
\125\ PSA argued to the contrary, pointing to its study of seven
companies which ostensibly shows that 99% of MLM distributors earn
no profit from company rebates, and further stating that it is
practically impossible for distributors to earn money through
product sales. PSA, The Myth at 24, 29 (reviewing pay-outs that
seven MLM companies made to distributors between 1998 and 2004). But
see Primerica Rebuttal, at 5 (characterizing the data as ``both
unrepresentative and unreliable.'').
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Sharply diverging from the comments of industry advocates are those
of consumer advocates who argued that by and large, MLMs victimize
consumers by claiming to provide an opportunity to earn money that
cannot realistically be achieved. The Commission's law enforcement
experience shows that some MLMs have violated the law by making false
earnings representations and have operated as pyramid schemes. In the
last ten years, the Commission has sued fourteen pyramid schemes that
purported to be legitimate MLM businesses selling products to end-
users.\126\FTC v. Equinox International Corp. provides a prime example
of how a pyramid scheme could masquerade as a legitimate MLM. Equinox
purported to offer distributorships to sell products, including water
filters, vitamins, nutritional supplements, and skin care
products.\127\ However, the company emphasized to new distributors that
the real way to make money was through recruiting additional
distributors, not through product sales. The company extracted money
from its recruits by encouraging them to enter the MLM at the
``manager'' level, which required a purchase of $5,000 worth of
products; to rent desk space for $300 to $500 per month; to subscribe
to a phone line so they could recruit others; and to attend trainings
and seminars at a cost of $300 to $1,000.
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\126\ FTC v. BurnLounge, No. 2:07-cv-03654-GW-FMO (C.D. Cal.
2007); FTC v. Mall Ventures, Inc., No. CV 04-0463 FMA (PLAx) (C.D.
Cal. 2004); FTC v. NexGen3000.com, No. 03-120 TUC WDB (D. Ariz.
2003); FTC v. Trek Alliance, Inc. , No. CV-02-9270 (C.D. Cal. 2002);
FTC v. Streamline Int'l, Inc., 01-6885-CIV-Ferguson (S.D. Fla.
2001); FTC v. Bigsmart.com, No. CIV 01- 0466 PHX ROS (D. Ariz.
2001); FTC v. Netforce Seminars, Inc., No. 00 2260 PHX FJM (D. Ariz.
2000); FTC v. 2Xtreme Performance Int'l, LLC, No. Civ. JFM 99CV 3679
(D. Md. 1999); FTC v. Equinox Int'l, Corp., No. CV-S-99-0969-JBR-RLH
(D. Nev. 1999); FTC v. Five Star Auto Club, Inc., No. CIV-99-1693
McMahon (S.D. N.Y. 1999); FTC v. FutureNet, Inc., No. CV-98-1113 GHK
(C.D. Cal.1998); FTC v. JewelWay, No. 97-383 TUC JMR (D. Ariz.
1997); FTC v. World Class Network, Inc., No. SACV-97-162-AHS (Eex)
(C.D. Cal. 1997); FTC v. Mentor Network, Inc., No. SACV 96-1104 LHM
(Eex) (C.D. Cal. 1996).
\127\ See http://www.ftc.gov/opa/1999/08/equinox1.shtm.
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Equinox had ostensibly implemented safeguards to show it was not a
pyramid scheme. For example, Equinox purported to link compensation to
retail sales, including requiring distributors to produce receipts
showing retail purchases. However, the evidence revealed that such
policies were not enforced.\128\ Like other members of the DSA, Equinox
purported to offer refunds on inventory purchases. Yet, the net loss to
consumers who participated in Equinox was more than $330 million.\129\
Indeed, pyramid schemes masquerading as legitimate MLMs can implement
numerous purported safeguards to appear legitimate.\130\
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\128\See also FTC v. Trek Alliance, Inc., CV-02-9270 (C.D. Cal.
2002); http://www.ftc.gov/opa/2003/08/trek.shtm.
\129\ Documented proof of claim forms received from consumer-
victims of Equinox reveal that the net loss to consumers was at
least $330 million. The defendants settled FTC charges by paying
cash, corporate and individual assets in the amount of nearly $50
million, which comprised virtually all the assets of the defendants.
As part of the settlement, the individual defendant, William Gouldd
was barred permanently from engaging in any multi-level marketing
operations. See http://www.ftc.gov/opa/2000/04/equinox.shtm.
\130\ In Webster v. Omnitrition Int'l, Inc., distributors sued
Omnitrition, an MLM company, alleging that it was a pyramid scheme.
The Ninth Circuit reviewed the safeguards that the MLM purportedly
used to ensure retail sales. Webster v. Omnitrition Int'l, Inc., 79
F.3d 776 (9th Cir. 1998). These included requiring no payment to
become a distributor; imposing no quota of products that
distributors were required to buy from the MLM; imposing an
affirmative obligation that distributors certify that 70% of
products they ordered have been resold and that they have made sales
to at least 10 retail customers in the past month; and affording a
90% refund on resaleable inventory if the distributor resigns from
the company. Id. at 780. In spite of these safeguards, the Ninth
Circuit concluded that summary judgment in favor of Omnitrition was
inappropriate because ``the structure of the scheme suggests that
Omnitrition's focus was in promoting the program rather than selling
the products.'' Id. at 782. The Court further noted that Omnitrition
failed to show that it enforced its 70% resale rule or its buy-back
rule on distributors. Id. at 784.
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Apart from operating as illegal pyramids, MLMs also could be
engaged in making false earnings representations. In the Commission's
law enforcement experience, all of its pyramid cases\131\ against
purportedly legitimate MLMs alleged that the defendant made false
earnings representations. Notably, at least one other case the
Commission brought against an MLM company alleged false earnings
representations.\132\ Nevertheless, MLM industry advocates
[[Page 16119]]
argue that a government regulation is not needed to protect individuals
taking low financial risks, such as the great many MLM distributors who
participate on a part-time or seasonal basis. However, while MLM
commenters contended that the cost of joining is typically very small,
they often referred only to the minimum required fees, and did not
mention all costs necessary to qualify for higher levels of
compensation.\133\ Such costs are problematic to the extent that MLM
firms market their distributorships with lifestyle representations\134\
that do not correlate to the small part-time income that active MLM
distributors primarily earn.\135\
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\131\See supra note 126.
\132\In re Nu Skin Int'l Inc., Docket C-3489, 117 F.T.C. 316,
324 (1994).
\133\ In Webster v. Omnitrition, the Ninth Circuit observed that
while there was no cost to becoming a distributor in the MLM
company, the cost of qualifying for higher compensation was
``substantial.'' 79 F.3d at 782.
\134\ Depending upon the particular representations, touting
grandiose lifestyles may be considered an earnings claim--rather
than mere puffery--that must be substantiated. The Commission has
long held that an earnings claim includes statements from which a
prospective purchaser could reasonably infer ``a specific level or
range of income,'' such as ``earn enough money to buy a new
Porsche.'' See Franchise Rule Final Interpretive Guides, 44 FR
49965, 49982 (Aug. 24, 1979).
\135\E.g., MLMIA, Appendix A at 13 (presenting a survey finding
that earnings for an average distributor are $418 per month); DSA at
15 (``A direct seller's median annual gross income from direct
selling is about $2,400 per year.''); Avon, at 19 (``those selling
on a part-time basis may show low earnings, which, in fact, may be
quite substantial given the amount of time they spend selling Avon
products.'').
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On the basis of its law enforcement experience and the rulemaking
record, the Commission concludes that some MLMs engage in unfair or
deceptive acts or practices. These practices include operation of
pyramid schemes and false or unsubstantiated earnings claims. It is
beyond a doubt that where they occur, these practices cause significant
consumer harm. The Equinox case alone illustrates that the harm to
consumers resulting from such practices is enormous--not just in the
aggregate, but individually.
The further question as to whether such deceptive practices are
prevalent, however, is elusive. It is difficult to gauge the incidence
of such practices among MLMs. As noted in more detail below,
determining whether a company operates as a pyramid requires a fact-
specific inquiry that depends on evaluating a number of factors. Even
if deceptive practices were established as prevalent in the MLM
industry, however, the Commission has determined at this time that
neither the IPBOR nor the alternative proposals that commenters
advanced appear likely to be sufficiently effective to remedy these
practices.
b. Whether the IPBOR or other proposals would reduce consumer harm
After careful consideration, the Commission believes that the
consumer harm flowing from deceptive practices in the MLM industry can
more effectively be addressed at this time through targeted law
enforcement under Section 5. Commenters on all sides generally agree
that the IPBOR's required disclosures would not help consumers identify
a fraudulent scheme. As discussed below, a simple earnings disclosure
is unlikely to enable consumers to determine whether an MLM company is
operating lawfully. Further, at this time, the record indicates that
the proposed alternatives that various commenters suggested would not
effectively counter deceptive practices and would not enable consumers
to avoid a fraud.
As commenters noted, an earnings disclosure, such as the one
proposed in the IPBOR, will not help prospective purchasers determine
whether an offering is a pyramid or is a legitimate MLM because it does
not reveal the source of the income.\136\ The main difference between a
pyramid scheme and a legitimate MLM is that the legitimate company
actually derives its income primarily from the retail sale of products
to end users, while the pyramid scheme supplies income to participants
at the top of the pyramid primarily through fees that new participants
pay for the right to participate in the venture.\137\ In a pyramid
scheme, a participant can reap rewards only by obtaining a portion of
the fees paid by those who join the scheme later. People who join
later, in turn, pay their fees in the hope of profiting from payments
of those who enter the scheme after they do. In this way, a pyramid
scheme simply transfers monies from losers to winners. For each person
who substantially profits from the scheme, there must be many more
losing all, or a portion, of their investment to fund those winnings.
Absent sufficient sales of goods and services, the profits in such a
system hinge on nothing more than recruitment of new fee-paying
participants into the system.
---------------------------------------------------------------------------
\136\See PSA, at 2; CAI, Red Flags at 5; Primerica at 26.
\137\See Staff Advisory Opinion--Pyramid Scheme Analysis,
January 14, 2004.
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As the Commission's cases demonstrate, the sale of goods and
services alone does not necessarily render a multi-level system
legitimate. Modern pyramid schemes display endless ingenuity in finding
ways to disguise payment of participation fees to appear as if they are
for the sale of goods or services. The source of the income typically
is not easy to discern from a facial examination of a company's
compensation structure and the safeguards it purportedly has in place.
Economic analysis of the MLM business model suggests a continuum with
clearly legitimate MLMs at one end and clearly fraudulent pyramid
schemes at the other. With some basic company information, a company
residing at one pole or the other can be identified. Nevertheless, in
the middle is a substantial gray area where differentiating the two is
much more difficult because the source of income is both sales of
products or services and participation fees.\138\ Indeed, the question
of whether a purportedly legitimate MLM is, in reality, only a pyramid
scheme in masquerade is a highly fact-intensive inquiry. That being the
case, the issue is a particularly difficult one to address via
industry-wide rulemaking, as opposed to case-by-case enforcement.
---------------------------------------------------------------------------
\138\ Vander Nat and Keep, at 149.
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Commenters have advanced three main alternatives to the specific
elements of the IPBOR: (1) granting a safe-harbor to companies that
implement certain safeguards; (2) requiring detailed earnings
information; and (3) defining what constitutes a pyramid scheme. As
explained in more detail below, at this time, the Commission is not
persuaded that any of these proposals would likely lead to a rule that
would not unfairly burden legitimate companies while rooting out
pernicious frauds dressed in the garb of legitimacy.
i. MLM comments advocating a safe harbor to exempt legitimate companies
would not adequately distinguish between pyramids and legitimate
companies
MLM industry commenters suggest limitations on the rule so that it
would exclude firms that require very low registration fees;\139\ firms
that offer refunds on inventory purchases;\140\ firms that are
publicly-traded;\141\ firms that have been in business for a
[[Page 16120]]
significant number of years;\142\ or firms that are members of a self-
regulatory body, such as the DSA.\143\ However, none of these factors
is determinative of whether a company is, in fact, a pyramid scheme or
otherwise engaged in deceptive conduct. Furthermore, the effort to
craft a workable rule using these criteria could undermine law
enforcement efforts if pyramid schemes masquerading as MLMs were able
to manipulate their corporate structure--as Equinox did--to meet safe
harbor provisions while continuing, in fact, to operate illegally.
---------------------------------------------------------------------------
\139\ Avon, at 10 (advocating that the Commission impose a
monetary threshold for required payments and that the rule not apply
to transactions below that threshold); Pre-Paid Legal, at 1
(advocating a monetary threshold of $250).
\140\ Quixtar, at 5; Melaleuca, at 7.
\141\ Pre-Paid Legal, at 1; Avon, at 10; Herbalife, at 16.
\142\ Primerica, at 41.
\143\ DSA, at 42.
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ii. Imposing the earnings disclosures that consumer groups suggest on
MLMs is fraught with problems and complexity
Consumer advocates advanced a requirement to disclose the retail-
based earnings of active and inactive participants, deducting the costs
distributors paid.\144\ There are several problems with this approach.
Given the complexities of each MLM's compensation schedule, developing
a standard, useful, understandable, and straightforward earnings
disclosure that would serve industry-wide is elusive. Further
complicating the problem are the practical considerations of whether
MLMs could, using an industry-wide format, gather reliable information
on retail earnings.
---------------------------------------------------------------------------
\144\ PSA, at 2; CAI, at 7.
---------------------------------------------------------------------------
More broadly, a number of issues would make it difficult to craft
an industry-wide rule on a proper earnings disclosure, as proposed
above. A meaningful earnings claim disclosure likely would require
different disclosures for different levels of participation in the
company. For example, how should such a disclosure treat inactive
participants who have joined merely to purchase product for their own
use as opposed to active participants in the earnings figure? How would
one identify participants who are inactive because they only wanted to
obtain access to the product at wholesale prices rather than those who
are inactive because they concluded that the business was not suitable
for them?\145\ How long after a participant's last sale should he or
she be considered ``inactive''?\146\ MLM companies often have
complicated compensation schedules that offer greater compensation for
greater sales volume. Moreover, because there likely is an earnings
disparity between new MLM recruits and distributors who have well-
established down-lines, an additional issue arises as to whether a
disclosure of participants' median income rather than average income is
most appropriate. In pyramids, a disclosure of average income would
suggest that all participants have the ability to make the claimed
earnings, when in reality, the earnings figure is skewed to reflect the
lavish profits reaped by those at the top of the pyramid. New recruits
to the pyramid scheme would not have any possibility of reaping such
profits. Median income, by contrast, would eliminate the outliers, thus
providing a more realistic picture of what the majority of participants
earn in a pyramid. Whether that is the most appropriate measuring stick
for a legitimate MLM company where earnings are based on retail sales
is unclear.
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\145\ The issue of inactive participants who are only interested
in obtaining product at wholesale prices appears to be unique to
MLMs. As far as the Commission is aware, this complication does not
arise in other forms of business opportunities. In the MLM context,
the record does not reveal the extent to which individuals join MLMs
to buy products at wholesale.
\146\E.g., Primerica Rebuttal at 34-35.
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Second, it may be difficult to determine retail income. While an
MLM firm may provide distributors with products, the MLM may not be
able to verify the extent to which a distributor has resold the product
at retail, is warehousing the product, or bought the product for his or
her own personal consumption. Even where an MLM has policies in place
purportedly to ensure that a portion of its distributors' income comes
from retail sales--as opposed to inventory loading--the company may
still lack accurate figures on the true amount of its distributors'
retail income.\147\ For example, such policies could go unenforced, or
even if they were ostensibly enforced, could be circumvented by
distributors, who may have an incentive to ``certify'' their sales in
order to qualify for higher level of commissions.\148\ Indeed, the
potential collusion between MLM companies and distributors to fake the
true level of retail sales would undermine the utility of an earnings
disclosure based on retail income.
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\147\Webster v. Omnitrition International, Inc., 79 F.3d 776,
783 (9th Cir. 1996) (stating that Omnitrition produced no evidence
that it enforced its rule ostensibly requiring its distributors to
sell at wholesale or at retail 70% of the products they bought).
\148\ In the Omnitrition case, the Ninth Circuit commented on
the requirement that distributors certify their sale of the product,
stating: ``There is no evidence that this `certification'
requirement actually serves to deter inventory loading.'' 79 F.3d at
783. Similarly, in the Commission case against Equinox, it was
alleged that the MLM looked away when distributors wrote their own
receipts to fake retail sales to consumers.
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The deduction of costs also is problematic. Primerica argued that
the proposal to deduct a distributor's costs, in particular, is
``administratively impossible'' because it ``require(s) information
that companies do not routinely possess and cannot easily
obtain.''\149\ For example, business-related expenses could include
independent costs that an MLM could not track, such as costs for
computers, office equipment, leasing office space and other
facilities.\150\ In addition, many commenters point out that MLM
participants use their membership to purchase products at a discount
for their own personal consumption.\151\ Deducting ``costs'' that
members pay to the MLM would be too broad insofar as it would include
inventory that distributors choose to purchase for themselves.\152\
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\149\ Primerica Rebuttal, at 34.
\150\ Primerica Rebuttal, at 35.
\151\See supra, note 75.
\152\ Primerica Rebuttal, at 6 (``Moreover, these commenters
allege losses based in part on counting as costs what the record
makes plain is a benefit for many participants--the ability to
purchase for personal consumption products they like at a
significant discount.'').
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In view of these difficulties, the Commission at this time believes
it is more cost-effective to challenge deceptive MLM practices through
targeted law enforcement under Section 5.\153\
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\153\ Regardless of whether it is covered by the proposed rule,
if a business makes earnings claims, including through the use of
testimonials, such claims must be truthful and must be
substantiated, under Section 5 of the FTC Act.
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iii. Crafting a definition of ``pyramid scheme'' would be counter-
productive
Some commenters advocated crafting a definition of ``pyramid
scheme'' that would avoid the problems of overbreadth in the IPBOR by
excluding legitimate MLMs from coverage while keeping pyramid schemes
covered.\154\ There are two practical difficulties with this approach.
First, as noted above, there is no bright-line, universal test for the
particular quantity of retail sales that in every case would suffice to
fund the payment of commissions for every MLM company. While economic
analysis can reveal if an individual company clearly is operating
legitimately or if it clearly is a pyramid scheme, it is difficult to
draw an appropriate line in the gray area.\155\
[[Page 16121]]
Second, any definition of ``pyramid scheme'' would provide bad actors
with a road map for restructuring their businesses to skirt the
definition, at least facially, and thereby providing them with a safe
harbor that could undercut law enforcement efforts.
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\154\E.g., Craig, at 7-8 (former Assistant Attorney General with
the State of Wisconsin); Primerica, at 38.
\155\See VanderNat and Keep, Marketing Fraud: An Approach to
Differentiating Multilevel Marketing from Pyramid Schemes, 21 J. of
Pub. Pol'y & Marketing, at 149. See also Primerica Rebuttal, at 35
(``As the extensive analysis contained in [consumer group] comments
demonstrates, identifying a pyramid scheme (or, at least, one that
attempts to disguise itself as a legitimate business opportunity)
entails an in-depth examination of the compensation structure and
the actual manner in which compensation flows within an
organization.'').
---------------------------------------------------------------------------
The benefit of using Section 5 to prosecute pyramid schemes is that
it is a flexible instrument that allows the Commission to pursue bad
actors no matter how they choose to manipulate their corporate
structure. At this time, and on the basis of evidence in the record,
the Commission declines to define ``pyramid scheme'' through rulemaking
but will continue to use Section 5 to attack such schemes.
c. Benefits and Burdens of the IPBOR
As set forth above in greater detail, MLM industry commenters
contend that the burdens of making the IPBOR's disclosures would be
devastating. Some of these concerns are overblown and clearly
misunderstand the intent of the IPBOR, which would not require
individual MLM distributors to disclose their personal litigation
histories, for example, to prospective purchasers.\156\ However,
numerous commenters made valid points about the direct cost of
complying and the indirect cost of loss recruitment. As one commenter
noted, with a dwindled sales force, there would be a consequent drop in
the sale of product, and the cost to one MLM, Primerica, would be $1
billion over ten years.\157\ Even if this figure grossly overestimates
the cost to individual MLM companies, millions of MLM distributors,
according to distributors and groups representing MLM distributors,
would individually bear the cost of lost recruitment and would find
their home businesses adversely affected.
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\156\E.g., Mary Kay, at 8, 9; MLMIA, at 9-10 (estimating that
there are 10 million business opportunity sellers in the
marketplace, and further stating: ``The Proposed Rule may actually
cause a recession in the United States if fully enforced.'').
\157\ Primerica, at 3, 4; Primerica Rebuttal, at 11.
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Commenters also argued that the burdens are unjustified because the
disclosure requirements are ill-suited to the MLM industry and would
fail to help consumers identify a risky opportunity. For example, the
requirement that business opportunity sellers disclose a list of prior
purchasers would be costly for covered companies but would not help
consumers analyze the possibility of loss because every prior purchaser
has an incentive to sell the opportunity in order to recruit additional
distributors into their ``down lines.'' Thus, they might not provide a
very reliable assessment of participating in the opportunity offered.
Similarly, to the extent individuals join MLMs only to purchase
products at wholesale, the waiting period would be an unnecessary
obstacle. And, as noted above, the earnings claim disclosure
requirement would itself be incomplete and possibly misleading because
it would be unlikely to capture and accurately portray the actual
source of compensation.
d. Conclusion
The deceptive practices of some companies using the MLM business
model, which operate as pyramids or disseminate false earnings claims,
remain a troubling consumer hazard. On the question of whether such
practices are prevalent, however, it is difficult to gauge the
incidence of such practices among MLMs. Even if the troubling practices
were established to be prevalent, the Commission is not persuaded at
this time that the proposed remedies would significantly redress
consumer harm in a cost-effective manner. The Commission believes that
the burdens that would be imposed upon legitimate business operations
would not appear to be justified by possible benefits to consumers. To
fashion a proper approach to combat fraud in the MLM industry, the
Commission will continue to examine the MLM industry and individual
companies, particularly the degree to which product sales fund the
compensation that distributors earn. At this time, however, the
Commission believes that the proposed rule is too blunt of an
instrument to cure fraud in the MLM industry. The Commission has
determined that it will use the flexibility inherent in Section 5 of
the FTC Act to address particular frauds in the MLM industry.
Section D. The Proposed Rule
To limit the proposed rule's scope, as discussed above, the
Commission now proposes a significantly revised Section 437.1,
redefining ``business opportunity.'' In addition, the Commission
proposes three changes to Section 437.3, which prescribes the content
of the basic disclosure document. Finally, the Commission also proposes
minor changes to Section 437.5, which addresses deceptive claims and
practices in connection with business opportunity sales. Each of these
proposals is discussed in detail below. In addition, this section
discusses commenters' recommendations for specific changes and the
Commission's reasons for adopting or not adopting them. As noted below,
the Commission continues to solicit commentary on all aspects of the
RPBOR.
1. Proposed Section 437.1: Definitions
As with the IPBOR, the RPBOR begins with a ``definitions'' section.
With the exception of the terms discussed specifically below, the
definitions in the RPBOR are the same as in the IPBOR. As noted, the
Commission proposes to narrow the scope of the proposed rule by
redefining the term ``business opportunity.'' The RPBOR eliminates the
previously defined term ``business assistance'' and adds a new term,
``required payment.'' In addition, the RPBOR slightly modifies the
definition of ``designated person'' and of ``providing locations.''
a. Proposed Section 437.1(c): ``Business opportunity''
The definition of ``business opportunity'' establishes the
parameters of the Rule's coverage. In the RPBOR, the Commission
proposes a tailored definition of ``business opportunity'' that will
reach those business opportunities that have, in the Commission's law
enforcement experience, persistently caused substantial consumer
injury. These include business opportunities promoting vending machine,
rack-display, work-at-home, medical billing, and 900-number schemes,
among others.
The three definitional elements of the term ``business
opportunity'' in the RPBOR are: (1) a solicitation to enter into a new
business; (2) a ``required payment'' made to the seller; and (3) a
representation that the seller will provide assistance in the form of
securing locations, securing accounts, or buying back goods produced by
the business. The RPBOR incorporates and builds on the definition of
``business opportunity'' used in the original Franchise Rule and the
interim Business Opportunity Rule\158\ to cover these particular types
of schemes.\159\
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\158\ As noted previously, the interim Business Opportunity
Rule, found at 16 CFR 437, is the portion of the original Franchise
Rule that applied to business opportunities. It will remain
effective until the current rulemaking proceedings conclude.
\159\See Primerica, at 39 (suggesting that the Commission should
``[r]etain the existing definition from the Franchise Rule that
covers business opportunities and expand [it] based on demonstrated
problems.''); DSA, at 39-40.
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The changes to the IPBOR's definition of ``business opportunity''
are three-fold. First, the RPBOR definition includes a prong limiting
coverage to opportunities for which ``the
[[Page 16122]]
prospective purchaser makes a required payment'' for the purchase of
the business opportunity. This change will exclude from the definition
business relationships in which the only required payment is for
inventory at bona fide wholesale prices. Second, the RPBOR definition
eliminates two types of ``business assistance'' that formerly would
have triggered the Rule's strictures and disclosure obligations, namely
tracking payments and providing training. Third, the RPBOR no longer
links the definition of ``business opportunity'' to the making of an
earnings claim. Each of these changes is discussed in detail below.
1. Required payment
i. Inventory exemption
The RPBOR definition reaches only those opportunities where the
prospective purchaser of a business opportunity makes a required
payment to the seller. Proposed section 437.1(o) specifies that a
``required payment'' includes ``all consideration that the purchaser
must pay to the seller or an affiliate, either by contract or practical
necessity, as a condition of obtaining or commencing operation of the
business opportunity. Such payment may be made directly or indirectly
through a third party. A required payment does not include payments for
the purchase of reasonable amounts of inventory at bona fide wholesale
prices for resale or lease.''
The exclusion from the definition of inventory purchases at bona
fide wholesale prices of ``required payment'' effectuates the
Commission's determination that traditional product distribution
arrangements should not be covered by the Business Opportunity
Rule.\160\ Accordingly, the definition of ``required payment'' is
substantially similar to that employed in the recently amended
Franchise Rule,\161\ but also incorporates language from the IPBOR that
reaches situations where a payment is made either directly to the
seller or indirectly through a third party.\162\
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\160\See supra C.1.
\161\See 16 CFR 436.1(s).
\162\ As noted in the NPR, this provision is designed to close a
potential loophole that would subvert the proposed rule's anti-fraud
protections. Without such a provision, fraudulent business
opportunity sellers could circumvent the Rule by requiring payment
to a third party with which the seller has a formal or informal
business relationship. While this concept appeared in the IPBOR's
definition of ``business opportunity,'' it is now incorporated into
the definition of ``required payment.''
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The inventory exemption was originally set forth by the Commission
in its 1979 Final Interpretative Guide to the Franchise Rule.\163\ The
point of excluding payments for inventory was to exclude ``agency
relationships in which independent agents, compensated by commission,
sell goods or services (e.g., insurance salespersons).''\164\ Indeed,
as numerous commenters point out, manufacturers, suppliers, and other
traditional distribution firms ``have relied solely on the bona fide
wholesale price exclusion to avoid coverage as a franchise.''\165\
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\163\See Franchise Rule Final Interpretive Guides, 44 FR at
49967 (``the Commission will not construe as `required payments' any
payments made by a person at a bona fide wholesale price for
reasonable amounts of merchandise to be used for resale. The
Commission will construe `reasonable amounts' to mean amounts not in
excess of those which a reasonable businessman normally would
purchase by way of a starting inventory or supply or to maintain a
going inventory or supply.'').
\164\Id. at 49967-68.
\165\ Sonnenschein, at 1-2. See also NAA, at 1-3; Timberland, at
1 (noting that numerous manufacturers structure their retail
distribution in this manner); CTFA, at 4.
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The IPBOR had eliminated this concept in an attempt to bring
pyramid schemes that engaged in ``inventory loading'' within the ambit
of the Rule. As discussed above, however, the Commission has determined
that challenging such practices in targeted law enforcement actions
under Section 5 of the FTC Act is a more cost-effective approach than
attempting to address pyramid schemes as proposed in the IPBOR.
ii. Monetary threshold
Only business opportunities costing the purchaser at least $500 are
covered by the interim Business Opportunity Rule. The RPBOR, however,
would eliminate any monetary threshold for the required payment. Many
commenters, including MLM industry members as well as non-MLM product
distributers, urged the Commission to establish a minimum
threshold.\166\ A common theme in many comments submitted by the MLM
industry is that mandatory disclosures are not necessary or appropriate
for small investments.\167\ On the other hand, some commenters, such as
the National Consumers League (``NCL'') strongly support the proposal
to drop the financial threshold to zero, as a means of closing gaps
that would allow perpetrators of fraud room to avoid making
disclosures.\168\
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\166\E.g., DSA, at 37; Avon, at 10; Pre-Paid Legal, at 1;
Sonnenschein, at 5; Herbalife, at 15; IBOAI, at 4-5; IBA, at 9.
\167\E.g., Xango, at 4; Avon, at 12; Herbalife, at 3; Shure, at
1-2; Symmetry, at 1.
\168\ NCL, at 1, 2 (``[F]or many work-at-home victims, even
losses of less than $100 can have significant impacts. Some mention
living on fixed disability or retirement incomes, others are
desperately trying to supplement their wages in order to make ends
meet.''). See also ASTA, at 2.
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Many pernicious frauds, including typical work-at-home schemes,
have fallen outside the ambit of the original Franchise Rule's
disclosure obligations because it covered only a franchise or business
opportunity costing at least $500.\169\ These frauds have often
targeted vulnerable populations, such as the disabled, elderly, and
immigrant populations.\170\ Some commenters asserted that a monetary
threshold simply provides scam operators a means to circumvent the
Rule, noting that business opportunities sometimes charge $495 to skirt
the original Franchise Rule's disclosure requirements. For example, NCL
stated that the:
---------------------------------------------------------------------------
\169\See e.g., FTC v. Med. Billers Network, Inc., No. 05 CIV
2014 (RJH) (S.D.N.Y. 2005) ($200-295 fee); FTC v. Sun Ray Trading,
No. Civ. 05-20402-CIV-Seitz/Bandstra (S.D. Fla. 2005) ($160 fee);
FTC v. Wholesale Marketing Group, LLC, No. 05 CV 6485 (N.D. Ill.
2005) ($65 to $175 registration fees); FTC v. Vinyard Enterprises,
Inc., No. 03-23291-CIV-ALTONAGA (S.D. Fla. 2003) ($139 fee); FTC v.
Leading Edge Processing, Inc., 6:02-CV-681-ORL-19 DAB (M.D. Fla.
2002) ($150 fee); FTC v. Healthcare Claims Network, Inc., No. 2:02-
CV-4569 MMM (AMWx) (C.D. Cal. 2002) ($485 fee); FTC v.
Stuffingforcash.com, Corp., No. 92 C 5022 (N.D. Ill. 2002) ($45
fee); FTC v. Kamaco Int'l, No. CV 02-04566 LGB (RNBx) (C.D. Cal.
2002) ($42 fee); FTC v. Medicor LLC, No. CV01-1896 (CBM) (C.D. Cal.
2001) ($375 fee); FTC v. SkyBiz.com, No. 01-CV-0396-EA (X) (N.D.
Okla. 2001) ($125 fee); FTC v. Para-Link Int'l, No. 8:00-CV-2114-T-
27E (M.D. Fla. 2000) ($395 to $495 fee).
\170\E.g., FTC v. Juan Matos, No. 06-161429 CIV-Altonaga (S.D.
Fla. 2006) ($110 fee); FTC v. USS Elder Enterprises, Inc., No. SACV-
04-1039 AHS (Anx) (C.D. Cal. 2004) ($50 to $180 fees); FTC v. Castle
Publishing, Inc., No. AO3CA 905SS (W.D. Tex. 2003) ($59 to $149
fees); FTC v. Esteban Barrios Vega, No. H-04-1478 (S.D. Tex. 2003)
($79 to $149 fees).
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$500 minimum investment . . . leaves many consumers without the
disclosures and other protections that they need. Nearly one-third of
the consumers who reported to the NFIC last year that they had lost
money to fraudulent or deceptive business opportunities paid less than
$500. . . . Whatever minimum amount might be set, fraudulent operators
will price their services below it, and consumers will be
victimized.\171\
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\171\ NCL, ANPR 35, at 11. See also SBA Advocacy, ANPR 36, at 6
(``[T]hreshold should be lowered to $100 in order to curtail the
number of unsavory companies that are beyond the reach of the FTC
because they sell their scandalous `business opportunities' for
$495.''); M. Garceau, 20Nov97 Tr at 53 (``[I]t should be one
dollar''); D'Imperio, Sept95 Tr at 130 (``I don't care if it's $10,
fraud is fraud.''); Purvin, id. at 280 (``[C]ompanies use that
threshold to avoid regulation and consequently have their entry fee
be under $500, which seems to me forces the amount of money that a
prospective purchaser can lose within a very acceptable norm.'').
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Based upon this record and its law enforcement experience, the
Commission concludes that the scope of
[[Page 16123]]
the RPBOR should be broad enough to reach business opportunities that
our anti-fraud law enforcement history and consumer complaints show are
a widespread and persistent problem. To make the Rule sufficiently
broad to reach persistent frauds, such as work-at-home schemes and
envelope stuffing schemes, the RPBOR eliminates the monetary threshold.
Expansion of the Rule's coverage to reach these particular types of
fraud is balanced by significantly streamlined disclosure obligations,
which result in drastically reduced compliance costs. At the same time,
the RPBOR's more limited definition of the types of business assistance
that trigger coverage of the Rule, see infra, D.1.a.2., will avoid
blanket coverage of commercial arrangements for the purchase of a
business venture costing less than $500.
2. Limiting the type of business assistance that would trigger coverage
of the Rule
``Business assistance'' was a key definitional element of the term
``business opportunity'' in the IPBOR, and remains so in the RPBOR, but
with certain modifications intended to correct the IPBOR's overbreadth.
The IPBOR defined the term ``business opportunity,'' in relevant part,
as ``a commercial arrangement in which . . . the seller . . . either
makes an earnings claim or represents that the seller or one or more
designated persons will provide the purchaser with business
assistance.''\172\ In turn, the IPBOR defined ``business assistance''
as ``the offer of material advice, information, or support to a
prospective purchaser in connection with the establishment or operation
of a new business,'' and included five illustrative examples of the
kinds of activities considered to be ``business assistance'': securing
locations; securing accounts; buying back goods produced by the
business; tracking or paying commissions or other compensation for
recruitment or sales; and training or advising for the business.
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\172\ IPBOR, Sec. 437.1(d), 71 FR 19054 at 19087 (Apr. 12,
2006). (Emphasis supplied.)
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The RPBOR streamlines and narrows the scope of the definition of
``business opportunity'' by, among other things, incorporating the
concept of ``assistance'' into the ``business opportunity'' definition
itself, rather than cross referencing a separate ``business
assistance'' definition. Also, to cure the overbreadth of the IPBOR,
activities specified as fulfilling the ``assistance'' prong of the
``business opportunity'' definition of the RPBOR do not include:
tracking or paying commissions or other compensation for recruitment or
sales; or generalized training or advising.
The RPBOR retains the scope of the original Franchise Rule (as
currently set forth in the interim Business Opportunity Rule), in that
it includes location and account assistance in the definition of
``business opportunity.'' Indeed, the Commission's enforcement
experience shows that the offer of location assistance is the hallmark
of fraudulent vending machine and rack display route
opportunities,\173\ while account assistance is typical of medical
billing schemes.\174\
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\173\E.g., FTC v. Am. Entm't Distribs., No. 04-22431-CIV-Huck
(S.D. Fla. 2004); FTC v. Advanced Pub. Commc'ns Corp., No. 00-00515-
CIV-Ungaro-Benages (S.D. Fla. 2000); FTC v. Ameritel Payphone
Distribs., Inc., No. 00-0514-CIV-Gold (S.D. Fla. 2000); FTC v. Mktg.
and Vending Concepts, No. 00-1131 (S.D.N.Y. 2000).
\174\E.g., FTC v. Mediworks, Inc., No. 00-01079 (C.D. Cal.
2000); FTC v. Home Professions, Inc., No. 00-111 (C.D. Cal. 2000);
FTC v. Data Med. Capital, Inc., No. SACV-99-1266 (C.D. Cal. 1999).
See alsoFTC v. AMP Publ'n, Inc., No. SACV-00-112-AHS-ANx (C.D. Cal.
2000).
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Similarly, the RPBOR retains the example of ``buy back'' assistance
in the proposed definition of ``business opportunity'' because it is a
characteristic feature of work-at-home schemes promoting product
assembly and envelope stuffing schemes.\175\ The term, however, would
be broadened slightly to make explicit that any payments or promise of
payments for home-based envelope stuffing schemes come within the
parameters of the Rule. As such, the definition of ``business
opportunity'' is modified expressly to include: ``providing payment for
such services as, for example, stuffing envelopes from the purchaser's
home.''\176\ This is necessary because hucksters who offer envelope
stuffing opportunities commonly represent them as employment or quasi-
employment opportunities in which they will compensate participants
according to the number of envelopes they stuff.\177\
---------------------------------------------------------------------------
\175\E.g., FTC v. Misty Stafford, No. 3: CV 05-0215 (M.D. Pa.
2005); FTC v. USS Elder Enter. Inc., No. SACV-04-1039 AHS (ANx)
(C.D. Cal. 2004); FTC v. Holiday Magic, No. C 93-4038 VRW (N.D. Cal.
1994).
\176\ RPBOR, Section 437.1(c)(3)(iii).
\177\E.g., FTC v. Group C Marketing, Inc., No. CV-06-06019 (C.D.
Cal. 2006) (defendants represented they would pay $7 for every
envelope consumers stuffed); FTC v. Gregory Bryant, No. 3:04-CV-897-
J-32MMH (M.D. Fla. 2004) (defendants represented they would pay $4
for every envelope consumers stuffed and mailed); FTC v. America's
Shopping Network, Inc., No. 02-80540-CIV-Hurley (S.D. Fla. 2002)
(promising to pay $635 per week for processing mail); FTC v. Darrell
Richmond, No. 3:02-3972-22 (D.S.C. 2002) (offering to pay $2 per
envelope stuffed); FTC v. Financial Resources Unlimited, No. 03-C-
8864 (N.D. Ill. 2003) (offering to pay $10 per envelope).
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The RPBOR would exclude from its scope those commercial
arrangements where the only assistance the seller provides is tracking
payments. By so doing, the Commission takes MLM companies out of the
ambit of the Rule. Likewise, the RPBOR would exclude those sellers that
offer assistance only in: ``Advising or training, or purporting to
advise or train, the purchaser in the promotion, operation, or
management of a new business, or providing, or purporting to provide,
the purchaser with operational, managerial, technical, or financial
guidance in the operation of a new business.''\178\ While the
Commission's law enforcement experience shows that the promise of such
assistance is a feature of many fraudulent business opportunity
ventures, such as vending opportunities, rack display schemes, and
medical billing work-at-home schemes,\179\ these schemes are captured
adequately within the scope of the RPBOR. Defining ``business
assistance'' to include such advising or training would incorporate
such a broad array of traditional activities in legitimate commercial
relationships that the costs would outweigh the benefits that would be
generated as a result of including these
[[Page 16124]]
types of business assistance. For example, it could introduce the
unintended and unappealing specter of regulating certain educational
offerings.\180\ It also could include manufacturers who provide product
and sales training to third-party retailers.\181\ Therefore, the RPBOR
excludes ``advising or training'' as a form of assistance that would
trigger application of the Rule.
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\178\See IPBOR, 437.1(c)(5). Similarly, the RPBOR also
eliminates the term ``training'' from the IPBOR's definition of the
term ``providing locations, outlets, accounts, or customers.'' See
IPBOR, 437.1(n). In the RPBOR, ``providing locations'' remains a
form of business assistance that would trigger the coverage of the
rule. See RPBOR, 437.1(c)(3)(ii) and 437.1(l). This change avoids
the possibility that the use of the term ``training'' in the
definition of ``providing locations,'' at Section 437.1(l), could be
interpreted as a ``catch-all'' inadvertently sweeping into the ambit
of the rule such businesses as manufacturers that provide sales
training or educational institutions. However, the elimination of
the word ``training'' from the definition of ``providing locations''
does nothing to erode the long-standing interpretation of ``location
assistance'' in the original Franchise Rule to reach, potentially,
circumstances where a seller ``instructs investors on how to find
their own profitable locations.'' Staff Advisory Opinion 95-10, Bus.
Franchise Guide (CC) ] 6475 (1995) (noting that assistance must be
more than nominal). The Commission solicits comment on whether the
revision to Section 437.1(l) cures potential over-breadth without
sacrificing the full extent of coverage of the original rule, as
described in Staff Advisory Opinion 95-10.
\179\E.g., FTC v. Inspired Ventures, Inc., No. 02-21760-CIV-
Jordan (S.D. Fla. 2002); FTC v. Inv. Dev. Inc., No. 89-0642 (E.D.
La. 1989); FTC v. Home Professions, Inc., No. 00-111 (C.D. Cal.
2000); FTC v. Star Publ'g Group, Inc., No. 00-023 (D. Wyo. 2000);
FTC v. Hi Tech Mint Sys., Inc., No. 98 CIV 5881 (JES) (S.D.N.Y.
1998); FTC v. Fresh-O-Matic Corp., No. 96-CV-315-CAS (E.D. Mo.
1996); FTC v. Joseph Hayes, No. 4:96CV06126SNL (E.D. Mo. 1996). See
Illinois Act, 815 ILCS at Sec. 602/5-5.15 (The seller offers a
marketing plan, defined as ``advice or training . . . includ[ing],
but not limited to . . . training, regarding the promotion,
operation or management of the business opportunity; or operational,
managerial, technical, or financial guidelines or assistance.'').
\180\See supra note 45.
\181\See Timberland, at 1.
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3. Earnings claims
One major revision to the IPBOR is that the making of an earnings
claim no longer is sufficient to bring a commercial arrangement within
the definition of ``business opportunity.'' This revision addresses the
concerns that numerous commenters articulated, namely, that because the
definition of ``earnings claim'' is very broad, the IPBOR's definition
of business opportunity would transform common commercial transactions
into ``business opportunities.''\182\
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\182\E.g., IBA, at 4; PMI, at 2; MMS, at 2; Venable, at 1-2.
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The Commission considered but does not believe that narrowing the
definition of ``earnings claims'' effectively addresses concerns with
over breadth. Moreover, narrowing the definition of ``earnings claims''
could weaken protections on the most salient feature of the sales
presentation by allowing sellers to avoid disclosing the numbers of
people who, for example, earned enough money to ``buy a Porsche,'' or
earned the top level of compensation on an earnings matrix.\183\
Earnings claims lie at the heart of business opportunity fraud, and are
typically the enticement that persuades consumers to invest their
money. The disclosure obligations in the RPBOR, as in the Franchise
Rule, are designed to help a consumer identify and evaluate an earnings
claim, if one is made, or to arouse suspicion if an earnings claim is
made orally but is disclaimed in writing. If the RPBOR were to create
opportunity for a potential loophole on this critically important
issue, certainly unscrupulous business opportunity sellers would be
very quick to exploit it, to the great detriment of consumers.
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\183\See RPBOR, 437.1(f).
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Therefore, the Commission believes a better approach is to tailor
the substantive scope of the Rule rather than to narrow or restrict the
definition of ``earnings claims.'' The RPBOR is intended to cover all
variations of earnings representations that the Commission's law
enforcement experience shows are associated with business opportunity
fraud. Indeed, the definition of earnings claims is long-standing, as
it is taken from the description of earnings claim in the original
Franchise Rule, and incorporates examples taken from the UFOC
Guidelines as well as the Interpretive Guides to the Franchise
Rule.\184\
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\184\See UFOC Guidelines, Item 19; Staff Advisory Opinion, Handy
Hardware Centers, Bus. Franchise Guide (CCH) ] 6426 (1980);
Interpretive Guides, 44 FR at 49982.
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The Commission does not believe that this change undermines the
utility of the RPBOR in addressing fraud in connection with earnings
claims. It simply unlinks the definition of ``business opportunity''
from the making of an earnings claim.
b. Proposed Section 437.1(d): ``Designated person''
The RPBOR makes a minor modification to the IPBOR's definition of
``designated person.'' The IPBOR's definition ended with an example of
the type of person who could be considered a ``designated person,''
which included, without limitation, ``any person who finds or purports
to find locations for equipment.'' The RPBOR eliminates this concluding
language because the definition of ``business opportunity'' lists the
types of assistance a ``designated person'' might render or purport to
render. To avoid any possibility of confusion by including one example
but not all three in the definition of ``designated person,'' the
Commission deletes the example. A ``designated person'' is defined in
the RPBOR as ``any person, other than the seller, whose goods or
services the seller suggests, recommends, or requires that the
purchaser use in establishing or operating a new business.''
c. Proposed Section 437.1(l): ``Providing locations''
Section 437.1(l) of the RPBOR differs in some respects from the
analogous provision in the IBPOR. It would define ``providing
locations, outlets, accounts, or customers'' as:
furnishing the prospective purchaser with existing or potential
locations, outlets, accounts, or customers; requiring, recommending, or
suggesting one or more locators or lead generating companies; providing
a list of locator or lead generating companies; collecting a fee on
behalf of one or more locators or lead generating companies; offering
to furnish a list of locations; or otherwise assisting the prospective
purchaser in obtaining his or her own locations, outlets, accounts, or
customers.
The RPBOR would alter the definition of ``providing locations,
outlets, accounts, or customers,'' slightly by adding the phrases
``providing a list of locator companies'' and ``offering to furnish a
list of locations.'' In its comment, the United States Department of
Justice, Office of Consumer Litigation (``DOJ''), which has a long
history of cooperating with the Commission to enforce the Franchise
Rule,\185\ pointed out that many fraudulent business opportunities
simply provide lists of locators or locations. DOJ noted that while the
definition included in the IPBOR could be read to include such
scenarios, it would be useful to make the rule cover such practices
explicitly. Indeed, DOJ's concerns resonate with the Commission's law
enforcement experience, and the Commission agrees that the rule text
should explicitly address this specific practice. Further, the
definition is also modified to incorporate the term ``lead generator''
into the third clause, thus adding symmetry to the definition, which
refers to ``lead generators'' in all other clauses. Thus, the third
clause in Section 437.1(l) now includes: ``providing a list of locator
or lead generator companies.''
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\185\ As it points out in its comment, between 1995 and July of
2006, DOJ filed 61 lawsuits alleging Franchise Rule violations by
145 defendants. DOJ, at 1 n. 1.
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Finally, the words ``or training'' are deleted from the last clause
of Section 437.1(l) to avoid the possibility that it could be
interpreted as a ``catch-all'' capturing any business offering to
provide training. The revision leaves intact the phrase ``or otherwise
assisting the prospective purchaser in obtaining his or her own
locations, outlets, accounts, or customers.'' To determine whether a
seller provides the requisite assistance in providing locations,
outlets, accounts or customers, the Commission will continue to apply
its longstanding analysis, which considers the kinds of assistance the
seller offers and the significance of that assistance to the
prospective purchaser (e.g. whether the assistance is likely to induce
reliance on the part of the prospective purchaser).\186\
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\186\See Staff Advisory Opinion 95-10, Bus. Franchise Guide (CC)
] 6475 (1995). See also supra note 178.
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2. Proposed Section 437.3: The Basic Disclosure Document
Proposed Section 437.3 specifies the items of material information
that must be included in the basic disclosure document. As explained in
the NPR, the seller of the business opportunity is the
[[Page 16125]]
party responsible for providing the basic disclosure document to
prospective purchasers, and the seller must present the required
information in ``a single written document in the form and using the
language set forth in Appendix A to part 437.'' The Commission has
retained an expert to assess the basic disclosure document as proposed,
with the objective of achieving a format and content that communicates
the material information to consumers. The Commission welcomes comments
on all aspects of the RPBOR; commentary on the proposed form, however,
would be most useful if accompanied by quantitative or qualitative
studies on the effectiveness of the form, with specific suggestions for
potential improvement.
The RPBOR makes three modifications\187\ to the IBPOR with respect
to the information that must be presented on this document: (1) a
citation to the Rule would be added to the title of the form; (2) the
disclosure of legal actions pertaining to a seller's sales
representatives would be deleted from the form; and (3) the disclosure
of the number of cancellations and refund requests would be deleted
from the form. These changes are discussed below.
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\187\ Additionally, the ``earnings'' section of the disclosure
document is modified slightly to include a disclosure of earnings
claims the seller ``has stated or implied.'' The use of the past
tense makes clear to a seller completing the form that it must
identify earnings claims made over the course of marketing the
business opportunity to the consumer, and not just those claims made
at the moment of providing the disclosure document.
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a. Proposed Section 437.3(a): Form of the basic disclosure document
The form and language of the basic disclosure document is set forth
in Appendix A to the RPBOR. While the Commission received a plethora of
commentary on the substantive disclosures to be included in the basic
disclosure document, it received hardly any commentary on the language
used in the proposed form. The Commission received a persuasive comment
by DOJ, advising the Commission to add to the title a citation to the
legal authority requiring the seller to provide the basic disclosure
document. The Commission has decided to adopt this suggestion.
As discussed above, DOJ has substantial expertise in enforcing the
Franchise Rule, and has the authority to seek civil penalties for
violations of trade regulation rules issued pursuant to the FTC
Act.\188\ To obtain civil penalties for infractions of an FTC rule,
however, the government must prove ``actual knowledge or knowledge
fairly implied on the basis of objective circumstances that such act is
unfair or deceptive and is prohibited by such rule.''\189\ According to
DOJ, its experience is that individuals who market business
opportunities sometimes claim that they simply copied their disclosure
documents from a previous employer, suggesting that they did not know
their disclosure documents were in violation of any rule. Including a
short reference to the rule would ``eliminate[ ] any significant
question as to whether the defendant had actual or implied knowledge as
required by the statute.''\190\
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\188\ 15 U.S.C. Sec. 56(a)(1); Sec. 45(m)(1)(A) .
\189\ 15 U.S.C. Sec. 45(m)(1)(A).
\190\ DOJ at 2.
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The Commission agrees with DOJ. As numerous commenters have noted,
law enforcement is critical to eliminating malfeasance from the
marketplace.\191\ DOJ's suggested minor modification to the form
promises to advance the government's ability to enforce the law through
the use of civil penalties. Therefore, the title of the proposed form
on Appendix A has been modified to add the language ``Required by
Federal Trade Commission, 16 C.F.R. Part 437.''
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\191\E.g., Haynesboone, at 5 (urging the Commission to focus
more resources on enforcement); DRA, at 2.
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b. Proposed Section 437.3(a)(3): Legal Actions
Proposed Section 437.3(a)(3) would address fraud in the sale of
business opportunities by requiring the disclosure of material
information about certain prior legal actions\192\ involving the
company, its directors, and certain sales employees. This requirement
is based on analogous provisions of the original Franchise Rule.\193\
Commenters raised two distinct issues regarding the disclosure of prior
legal actions. First, some commenters, primarily members of the MLM
industry, argued that this disclosure obligation would not result in
consumers receiving meaningful information, and could unfairly tarnish
the image of a seller who has been sued but has not been found
liable.\194\ Second, some commenters argued that state laws conflict
with the requirement in the IPBOR that sellers report the litigation
histories of their sales employees.\195\
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\192\ The Commission notes that the definition of ``actions'' in
the RPBOR is different from that employed in the amended Franchise
Rule. The reason for that and other differences is that the two
rules were crafted to achieve different objectives and to govern
different types of business transactions. To provide one example, a
major objective of the amended Franchise Rule was to harmonize it
with various state law requirements and, thus, maximize uniformity
of laws at the federal and state level governing business-format
franchises. That objective is not present in the effort to amend the
interim Business Opportunity Rule. Therefore, there should be no
negative inferences drawn from the inclusion in or exclusion from
the RPBOR of any particular terms used in the amended Franchise
Rule.
\193\ The Commission stated in the original Franchise Rule's SBP
that litigation history is material because it bears on the
``integrity and financial standing of the [seller].'' 43 FR at
59649. A disclosure of litigation history is also incorporated into
the interim Business Opportunity Rule. 16 CFR 437.1(a)(4).
\194\E.g., Melaleuca, at 6; Quixtar, at 35; Amsoil, at 2;
Babener, at 2.
\195\ Venable, at 11; Chadbourne, at 20; Shaklee, at 10, 12.
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With respect to the first point, the Commission disagrees that the
disclosure of prior legal actions does not impart meaningful
information to consumers. This and other proposed material disclosures
on the form are intended to help consumers understand and assess the
risks of their prospective investment. The Commission believes that
information about litigation history in the areas of
``misrepresentation, fraud, securities law violations, or unfair or
deceptive practices,'' is material to assessing that risk. Indeed,
discovering that a seller has a history of violating laws and
regulations is perhaps the best indication that a particular business
opportunity is a high-risk investment. In the Commission's law
enforcement experience, business opportunity promoters have failed to
disclose such material information to prospective purchasers, to the
detriment of those purchasers.\196\ Regarding the concern that
businesses will be unfairly tarnished, nothing in the RPBOR prevents
the seller from speaking with the consumer to explain the nature or
outcome of any legal action disclosed on the form.\197\
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\196\E.g., FTC v. Success Vending Group, Inc., No. CV-S-05-0160-
RCJ-PAL (D. Nev. 2005) (failure to disclose guilty plea for mail
fraud and previous injunction); FTC v. Netfran Development Corp.,
No. 1:05-cv-22223-UU (S.D. Fla. 2005) (failure to disclose FTC
injunction against principal); FTC v. American Entm't Distribs.,
Inc., No. 04-22431-Civ-Martinez (S.D. Fla. 2004) (failure to
disclose prior FTC injunction); United States v. We The People Forms
and Serv. Centers USA, Inc., No. CV 04 10075 GHK FMOx (C.D. Cal.
2004) (failure to disclose prior lawsuits); FTC v. Joseph Hayes, No.
Civ. 4:96CV02162SNL (E.D. Mo 1996) (failure to disclose prior state
fines and injunctive actions); FTC v. WhiteHead, Ltd, Bus. Franchise
Guide (CCH) ] 10062 (D. Conn. 1992) (failure to disclose fraud
action); FTC v. Inv. Dev. Inc., Bus Franchise Guide (CCH) ] 9326
(E.D. La. 1989) (failure to disclose insurance fraud convictions).
\197\ As noted above, some members of the MLM industry voiced
concern about making extensive litigation disclosures because they
are affiliated with numerous other companies. In the context of such
an MLM, it could be impractical for a consumer to ask about every
legal action listed on the disclosure form, and thus, the form
itself may be unduly prejudicial to the MLM. Given the RPBOR as now
tailored, such concerns are unlikely to be raised in the context of
typical business opportunity schemes.
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[[Page 16126]]
With respect to the second issue concerning the disclosure of legal
actions pertaining to sales employees, IPBOR, 437.3(a)(3)(D), the
Commission believes it would be appropriate to exclude these employees
from the disclosure requirement. Some commenters suggested that this
provision would be inconsistent with state employment laws, but they
did not cite to specific statutes in which a conflict would necessarily
arise.\198\ The IPBOR's requirement to disclose the litigation history
of sales employees was intended to enable a prospective purchaser to
evaluate the representations made by a sales person. The Commission now
believes that the burden of collecting litigation histories for every
sales person is not outweighed by the corresponding benefit to
prospective purchasers. In the Commission's law enforcement experience,
sales representatives often work from sales scripts that someone with
supervisory authority has developed. A problem emerges when companies
conceal the litigation history of the person with supervisory authority
by claiming that individual is just a sales person. The Commission
believes that it is sufficient to require business opportunity sellers
to disclose the litigation histories of their principals, officers,
directors, and sales managers, as well as any individual who occupies
``a position or performs a function similar to an officer, director, or
sales manager of the seller.'' In this way, the RPBOR is sufficient to
enable prospective purchasers to ferret out situations where
recidivists, ostensibly employed as sales personnel, in fact function
as de facto officers or directors. Therefore, in the RPBOR, the
Commission deletes paragraph (D) from section 437.3(a)(3) of the IPBOR.
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\198\ Venable, at 11; Chadbourne, at 20; Shaklee, at 10, 12. A
California statute forbids employers from inquiring into histories
of arrests that did not result in convictions. Cal. Lab. Code Ann.
Sec. 432.7(a) (Deering 2007). It is not clear how this would
conflict with the RPBOR, which would not require disclosure of
arrest records.
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c. Proposed Section 437.3(a)(4): Cancellation or refund history
Section 437.3(a)(4) of the IPBOR would have required a seller both
to state on the basic disclosure document whether it has a cancellation
or refund policy, and to disclose the number of purchasers who had
asked to cancel or who had sought a refund in the two previous
years.\199\ This second disclosure was included as a remedy against
false representations about the success of prior purchasers. This is a
misrepresentation the Commission has observed in many of its law
enforcement actions against fraudulent business opportunity
sellers.\200\ In the NPR, the Commission specifically sought comment on
the proposed disclosure of the seller's refund history, particularly on
the likely effect this disclosure might have on the willingness of
sellers to offer refunds.\201\ Based upon the arguments articulated in
the comments to the NPR, the Commission no longer believes this second
disclosure is useful, and revises 437.3(a)(4) accordingly.
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\199\ IPBOR, 437.3(a)(5).
\200\E.g., FTC v. National Vending Consultants, Inc.,CV-S-05-
0160-RCJ (PAL) (D. Nev. 2005); FTC v. Fidelity ATM, Inc., No. 06-
CIV-81101 (S.D. Fla. 2006).
\201\ 71 FR at 19070.
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Some commenters persuasively argued that requiring disclosure of a
seller's refund history would have the perverse effect of discouraging
legitimate businesses from offering refunds.\202\ Commenters argued
that legitimate businesses often have liberal refund policies so they
can provide a low-risk opportunity. If they were required to track and
disclose the number of purchasers who took advantage of the refund
policy, however, the disclosure of such information might create a
misleading impression of general dissatisfaction. It might cause
prospective purchasers to misinterpret risk, and therefore eschew a
safe opportunity.
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\202\See supra note 72. The comments on this issue came from
members of the MLM industry. While the RPBOR has been pared back to
exclude MLMs, the Commission is persuaded that their commentary on
this issue can be applied to business opportunities that remain
within the scope of the Rule.
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The Commission is persuaded that the disclosure of refund history
could be unduly prejudicial to business opportunities that offer and
liberally provide refunds to prior purchasers. Indeed, a prospective
purchaser might compare the refund requests of a fraudulent seller with
no refund policy against a legitimate seller with a liberal refund
policy and inappropriately conclude that the legitimate seller offers a
riskier business venture. Thus, the disclosure would not reliably
remedy deception on this issue. Furthermore, the most important piece
of information for consumers is not how many individuals sought
refunds, but what are the particular requirements of the refund or
cancellation policy. This information is not likely to create perverse
results or mistaken impressions. Therefore, Section 437.3(a)(4) of the
RPBOR requires disclosure of the refund policy, but eliminates section
437.3(a)(5) of the IPBOR, which would have required disclosure of the
seller's refund history.\203\
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\203\ This change reverts back to the requirements of the
original Franchise Rule which did not require a business to tally
the number of refund or cancellation requests but did require
disclosure of refund policies. See 16 CFR 437.1(a)(7) (interim
Business Opportunity Rule).
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d. Proposed Section 437.3(a)(6): References
After analyzing commentary to Section 437.3(a)(6) of the RPBOR, the
Commission leaves intact the IPBOR's language requiring the disclosure
of a limited number of prior purchasers as references.\204\ The
Commission believes that the disclosure of prior purchasers is very
important to prevent fraud because it enables prospects to evaluate the
seller's claims based on information from an independent source with
relevant experience. The Commission had solicited comment and
suggestions on balancing the need to enable prospective purchasers to
verify sellers' claims with privacy concerns.\205\ In addition to
seeking comment on possible alternatives, the Commission sought comment
on whether the Rule should permit purchasers the opportunity to opt-out
of the disclosure of their contact information.\206\
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\204\ The requirement to disclose prior purchasers was in
original Franchise Rule, and is now in the interim Business
Opportunity Rule. See 16 CFR 437.1(a)(16)(iii).
\205\ NPR, 71 FR at 19071.
\206\Id.
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The MLM industry articulated concerns peculiar to its business
model, but these provisions would no longer apply to MLM companies
inasmuch as these companies, and their representatives, are excluded
from the ambit of the RPBOR.
The MLM comments also suggested, more broadly, that the reference
disclosure requirement raised privacy and security concerns.\207\ The
Commission believes that the very limited proposed reference disclosure
does not raise security concerns because the required disclosures
include no sensitive personal information whatsoever, no social
security numbers, birth dates, or financial account numbers. The
disclosure requirement of nothing more than name, city, state, and
telephone number--covers less information than may be commonly
available in public telephone books.
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\207\E.g., Quixtar, at 33; Babener, at 2; Pre-Paid Legal,
Rebuttal, at 8; DRA, at 6.
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On the topic of privacy concerns, the Commission received a few
comments in support of allowing individual business opportunity
purchasers to opt
[[Page 16127]]
out of having their contact information disclosed.\208\ DOJ, however,
urged the Commission to reject any opt-out: ``The Rule should not
permit such an opt-out. It would be an easy matter for telemarketers to
talk consumers into opting out, describing to them what a hassle it
becomes for those who do not opt-out because of all the demand that
arises for their time and attention.''\209\ The Commission agrees with
DOJ that it is critical to provide prospective purchasers with a true
list of prior purchasers. By investing in a business opportunity, these
purchasers are entering the world of commerce and embarking upon the
establishment of a business. Businesses generally hold themselves out
as offering goods and services to the public.\210\ Therefore, the
Commission believes that the value to prospects of information about
prior purchasers outweighs any potential detriment to prior purchasers
of the disclosure of their contact information. The RPBOR leaves intact
section 437.3(a)(6).
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\208\E.g., Scarlet Leverton (affiliated with Lia Sophia); Kay
Gidley (affiliated with Universa Life Sciences); Joseph McGarry
(affiliated with Quixtar). These comments express generalized
privacy concerns.
\209\ DOJ, at 3.
\210\ Notably, federal law often focuses on privacy concerns
affecting individuals, not businesses. For example, Congress
specifically focused on the need to respect ``the consumer's right
to privacy,'' in enacting the Fair Credit Reporting Act (``FCRA'').
15 U.S.C. 1681(a)(4). The FCRA requires various protections for
consumer information, including provisions addressing identity
theft, but there is no comparable statute that protects business
information. Similarly, Congress enacted the Graham-Leach-Bliley Act
to protect personal financial information of individual consumers
but excluded from the ambit of the law the protection of information
pertaining to businesses. Graham-Leach-Bliley Act, 15 U.S.C. 6809
(9) (defining ``consumer'' to include individuals who obtain
financial products or services for personal, family or household
purposes). See also Privacy of Consumer Financial Information, 16
CFR 313.1(b) (expressly stating that it ``does not apply to
information about companies or about individuals who obtain
financial products or services for business, commercial, or
agricultural purposes.''); Standards for Safeguarding Customer
Information, 16 CFR 314.2(b) (defining ``customer'' by reference to
Part 313).
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3. Proposed Section 437.4: The Earnings Claim Document
Apart from the comments submitted by the MLM industry, the
Commission received little comment on the provisions in the proposed
earnings claim document. The one aspect of these provisions that drew
the most scrutiny from commenters was section 437.4(a)(vi), which
requires sellers who make earnings claims to disclose ``any
characteristics of the purchasers who achieved at least the represented
level of earnings, such as their location, that may differ materially
from the characteristics of the prospective purchasers being offered
the business opportunity.'' Here, commenters--primarily from the MLM
industry--argued that it would be extremely costly to undertake an
analysis of the various characteristics that successful purchasers had
in common.\211\ MLM companies peculiar concerns are no longer relevant
inasmuch as they are excluded from the scope of the RPBOR.
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\211\E.g., MLMIA, at 41 (``No one can hope to substantiate
accurately an earnings claim in a way that would take into account
and disclose every factor material to each person's earnings and to
contrast that with the characteristics of each prospective purchaser
without the expert advice of a person trained in marketing and
economics at the graduate level who in addition has experience in
making these kinds of assessments.... Legal and marketing
consultants are expensive.'').
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The Commission has decided to retain this provision in the RPBOR
because the information disclosed is material; it is intended to enable
the prospect to determine whether the claimed earnings of prior
purchasers are typical in the prospect's market. Furthermore, the
business opportunity seller is in the best position to know what set of
characteristics, such as location in densely-populated areas, tend to
make their purchasers successful. The amended Franchise Rule imposes an
analogous obligation,\212\ and indeed, the RPBOR's earnings disclosure
obligation is similar to what the interim Business Opportunity Rule
already requires.\213\ The Commission continues to seek comment on this
topic, particularly on the question of the burdens upon business
against the benefit to prospective purchasers.\214\
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\212\ 16 CFR 436.5(s)(3)(ii)(A).
\213\ The interim Business Opportunity Rule requires earnings
claims be presented with a statement of the material bases and
assumptions upon which the claim is made. 16 CFR 437.1(b)(3);
437.1(c)(3).
\214\ As noted earlier, even without the RPBOR, any seller who
makes an earnings claim must be truthful in that assertion and must
substantiate the claim. If a seller makes an earnings claim that is
only relevant to a narrow subset of purchasers and the seller fails
to disclose that fact, the claim would violate Section 5 of the FTC
Act.
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On its own initiative, the Commission has decided to modify
slightly another provision of the IPBOR, section 437.4(a)(4)(v).
Section 437.4(a)(4)(iv) requires sellers who make earnings claims to
disclose the ``beginning and ending dates when the represented earnings
were achieved,'' and section 437.4(a)(4)(v) of the IPBOR further
required disclosure of the ``number and percentage of all purchasers
during the stated time period who achieved at least the stated level of
earnings.'' The revision clarifies a potential ambiguity: the
purchasers who must be counted are all those who purchased the business
opportunity before the ending date when the represented earnings were
achieved, not just individuals who purchased the business opportunity
during the stated time period. Thus, under the RPBOR's section
437.4(a)(4)(v), the seller must disclose: ``The number and percentage
of all persons who purchased the business opportunity prior to the
ending date in (iv) above who achieved at least the stated level of
earnings.''
4. Proposed Section 437.5: Other Prohibited Practices
In addition to mandating disclosures to prospective purchasers, the
IPBOR would have prohibited sellers from engaging in a number of
deceptive practices. The RPBOR retains these prohibitions, and would
add: (1) a substantive prohibition to section 437.5(e), and (2)
clarifying language to section 437.5(r). Each of these changes is
discussed immediately below.
a. Proposed Section 437.5(e): Misrepresenting the Law
The IPBOR would have prohibited sellers from ``[m]isrepresenting
that any governmental entity, law, or regulation prohibits a seller
from furnishing earnings information to a prospective purchaser.'' The
RPBOR would add a second numbered clause, further prohibiting
misrepresentations that any governmental entity, law or regulation
prohibits a seller from ``disclosing to prospective purchasers the
identity of other purchasers of the business opportunity.'' DOJ
suggests the above modification because, in its law enforcement
experience, it has encountered ``numerous fraudulent business
opportunity sellers who deflect consumer requests for current
distributors by falsely claiming that the law forbids disclosing their
identity, which of course, is exactly the opposite of the truth.''\215\
The Commission agrees that such a prohibition is appropriate, and will
help consumers understand that if the seller supplies no references, it
is because none exists or because the seller chooses not to make such
information available, which would contravene the RPBOR. Furthermore,
the prohibition on making false statements imposes no costs on
legitimate companies, and as such, serves simply to confer a
significant benefit to consumers.
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\215\ DOJ, at 2.
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[[Page 16128]]
b. Proposed Section 437.5(r): Failure to Disclose Payment of References
The RPBOR is intended to prohibit sellers from failing to disclose
payments to individuals identified as references or personal
relationships with such individuals. However, the language of the
second clause of this paragraph in the IPBOR does not state that what
must be disclosed is the relationship between the seller and the
reference.\216\ Therefore, the RPBOR adds clarifying language to the
opening clause of section 437.5(r), so that it prohibits a failure to
disclose, ``with respect to any person identified as a purchaser or
operator of a business opportunity offered by the seller,'' any
consideration paid, any personal relationship, or other unrelated
business relationship.
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\216\ This omission was noted in DOJ's comment, at 2.
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c. Proposed Section 437.5(c): Extraneous Materials
Like the IPBOR, the RPBOR's Section 437.5(c) would prohibit the
inclusion of any additional information in a disclosure document that
is not explicitly required or permitted by the Rule. The point of the
prohibition is to preserve the clarity, coherence, readability, and
utility of the disclosures by ensuring that the seller does not clutter
the disclosure document. The Commission sought comment on whether it is
appropriate to prohibit sellers from including in their disclosure
documents additional disclosures required by state business opportunity
laws.
DOJ urged the Commission to exclude state disclosures from the
proposed form. In DOJ's experience, ``[p]urveyors of fraudulent
business opportunities will seek every opportunity to water down this
document with extraneous information to hide any negative information
it may contain.''\217\
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\217\ DOJ, at 3.
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The original Franchise Rule permitted the inclusion of state
mandated disclosures in the federal disclosure document, where the
state disclosures provided equal or greater protection to prospective
purchasers.\218\ However, the original Franchise Rule required a very
lengthy disclosure, which included more than 20 categories of
information. Any additional state disclosures that afforded greater
protections to prospective purchasers were generally minor additions
that could be easily accommodated.\219\
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\218\ Original Franchise Rule, 16 CFR 436.1(a)(21).
\219\See Informal Staff Advisory Opinion, Bus. Franchise Guide
(CCH), Paragraph 6410 (April 15, 1980) (noting that there were only
three additional disclosures that Florida required affording greater
protection than the Franchise Rule).
---------------------------------------------------------------------------
The Commission agrees with DOJ that state disclosures should not be
bundled in to the same document with the proposed federal disclosure,
and therefore, the RPBOR retains Section 437.5(c) of the IPBOR. One
important goal of revising and tailoring the disclosure requirements of
the Franchise Rule for business opportunity promoters is to simplify
and streamline the disclosures into a single page document. Allowing
business opportunity promoters to mix federal and state disclosures
into one document would be an invitation to sellers to present lengthy
and confusing information to prospective purchasers. Such a result
would be contrary to the Commission's goal of providing a simple,
clear, and concise disclosure document.
5. Proposed Section 437.7: Exemptions
Section 437.7 of the IPBOR identifies entities that would be exempt
from complying with the Business Opportunity Rule. The exemption
applies to business opportunities that constitute franchises, and it
was designed to eliminate the possibility that a business would face
duplicative compliance burdens under the Business Opportunity Rule and
the amended Franchise Rule. However, it was also designed to ensure
that certain franchises exempt from the requirements of the Franchise
Rule --namely, those falling under the minimum payment exemption or the
oral agreement exemption\220\--would be covered by the Business
Opportunity Rule. To add precision and clarity to this provision, the
RPBOR revises Section 437.7 to adopt the language of the amended
Franchise Rule describing the relevant exemptions and to add specific
citations to the relevant provisions of Part 436.
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\220\ Amended Franchise Rule, 16 CFR 436.8(a)(1) & (a)(7).
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Many commenters argued for additional changes to the IPBOR,
including changing the definition of ``new business,'' exempting
purchasers of sufficient net worth, excluding transactions above a
monetary threshold, such as $50,000.\221\ These commenters essentially
argued that the Rule's application should encompass only those
transactions involving the vulnerable or unsophisticated purchasers
that they posited the Rule seeks to protect, and that exemptions should
be written into the Rule for sophisticated businesses that do not need
its burdens or protections.\222\
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\221\ Sonnenschein, at 2, 5,6; Snell, at 2, 4.
\222\Id.
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Having narrowed the scope of the proposed Rule considerably, the
Commission believes it has tailored the Rule's application to cover
only those business opportunities where fraud is most likely to occur.
In the Commission's law enforcement experience, these business
opportunities can cost tens of thousands of dollars, and seldom, if
ever, involve seasoned purchasers with sufficient expertise to
negotiate the terms of the transaction. There is an insufficient basis
at this time to conclude that further exemptions are necessary to avoid
covering transactions between sophisticated business people. However,
the Commission continues to solicit comment on whether the proposed
modifications to the scope of the Rule adequately capture the
marketplace in which fraud is prevalent or whether it is needlessly
over-inclusive.
Section E Rulemaking Procedures
Pursuant to 16 CFR 1.20, the Commission will use the following
rulemaking procedures. These procedures are a modified version of the
rulemaking procedures specified in Section 1.13 of the Commission's
Rules of Practice.
First, the Commission is publishing this Revised Notice of Proposed
Rulemaking. The comment period will be open until May 27, 2008,
followed by a rebuttal period until June 16, 2008. Interested parties
are invited to submit written comments. Written comments must be
received on or before May 27, 2008. Rebuttal comments must be received
on or before June 16, 2008. All comments should be filed as prescribed
in the ADDRESSES section above.
Second, pursuant to Section 18(c) of the Federal Trade Commission
Act, 15 U.S.C. 57a(c), the Commission will hold hearings with cross-
examination and rebuttal submissions only if an interested party
requests a hearing by the close of the comment period. In view of the
substantial revisions to the NPR, the Commission has held in abeyance
the hearing requests submitted in response to the NPR. Individuals who
continue to be interested in a hearing should, therefore, renew and
resubmit their requests in comments responding to this Revised NPR.
Parties interested in a hearing must submit within the comment period
the following: (1) a comment in response to this notice; (2) a
statement how they would participate in a hearing; and (3) a summary of
their expected testimony. Parties wishing to
[[Page 16129]]
cross-examine witnesses must also file a request by the close of the
20-day rebuttal period, designating specific facts in dispute and a
summary of their expected testimony. If requested to do so, the
Commission may hold one or more informal public workshop conferences in
lieu of hearings. After the close of the comment period, the Commission
will publish a notice in the Federal Register stating whether hearings
(or a public workshop conference in lieu of hearings) will be held and,
if so, the time and place of the hearings and instructions for those
wishing to present testimony or engage in cross-examination of
witnesses.
Finally, after the conclusion of the rebuttal period, and any
hearings or additional public workshop conferences, Commission staff
will issue a Report on the Business Opportunity Rule (``Staff
Report''). The Commission will announce in the Federal Register the
availability of the Staff Report and will accept comment on the Staff
Report for a period of 75 days.
Section F Communications to Commissioners and Commissioner Advisors by
Outside Parties
Pursuant to Commission Rule 1.18(c)(1), the Commission has
determined that communications with respect to the merits of this
proceeding from any outside party to any Commissioner or Commissioner
advisor shall be subject to the following treatment. Written
communications and summaries or transcripts of oral communications
shall be placed on the rulemaking record if the communication is
received before the end of the comment period. They shall be placed on
the public record if the communication is received later. Unless the
outside party making an oral communication is a member of Congress,
such oral communications are permitted only if advance notice is
published in the Weekly Calendar and Notice of ``Sunshine''
Meetings.\223\
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\223\See 15 U.S.C. 57a(i)(2)(A); 45 FR 50814 (1980); 45 FR 78626
(1980).
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Section G Paperwork Reduction Act
The Commission is submitting this proposed Rule and a Supporting
Statement for Information Collection Provisions to the Office of
Management and Budget (``OMB'') for review under the Paperwork
Reduction Act (``PRA''), 44 U.S.C. 3501-3521. In this notice, the
Commission proposes to amend a trade regulation rule governing business
opportunity sales. The proposed Rule would cover those business
opportunities currently covered by the interim Business Opportunity
Rule (and formerly covered by the original Franchise Rule, as explained
above), as well as certain others not covered by the interim Business
Opportunity Rule, including work-at-home programs. The proposed Rule
would require business opportunity sellers to disclose specified
information and to maintain certain records relating to business
opportunity sales transactions.
The currently approved estimates for disclosure and recordkeeping
burden under the interim Business Opportunity Rule, Part 437, includes
16,750 hours for business opportunity sellers. That estimate was based
on an estimated 2,500 non-exempt business opportunity sellers.\224\ As
discussed below, the proposed Rule would reduce the burden on business
opportunity sellers by streamlining disclosure requirements to minimize
compliance costs.\225\
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\224\ 71 FR at 19,081; 70 FR 51,818, 51,819 (August 31, 2005).
\225\ If the Commission ultimately amends the interim Business
Opportunity Rule, FTC staff will seek all necessary PRA clearances
and/or adjustments. The amended Franchise Rule and interim Business
Opportunity Rule have OMB clearance through October 31, 2008.
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The proposed Rule is designed to streamline and reduce
substantially the quantity of information business opportunity sellers
would be required to disclose. The proposals would impact such sellers
differently, depending upon whether they are currently covered by the
interim Business Opportunity Rule. The Commission staff estimates that
there are approximately 3,050 business opportunity sellers, comprised
of some 2,500 vending machine, rack display, and related opportunity
sellers, and 550 work-at-home opportunity sellers.
For the 2,500 vending machine, rack display, and related
opportunity sellers presently covered by the interim Business
Opportunity Rule, the proposed Rule would reduce the number of
disclosures from 20 categories of information to four mandatory
disclosures pertaining to earnings claims, lawsuits, refund policy, and
references. For the 550 business opportunity sellers presently exempted
from the interim Business Opportunity Rule, the disclosures, as noted
below, are streamlined to minimize compliance costs.
1. Reduced Mandatory Disclosures
The RPBOR contains four mandatory disclosures pertaining to
earnings claims, lawsuits, refund policy, and references. With respect
to earnings claims, business opportunity sellers must disclose whether
or not they make earnings claims. However, the decision to make an
earnings claim is optional. While the disclosures of references and
earnings claims retain, for the most part, the interim Business
Opportunity Rule requirements, the required disclosure of lawsuits is
reduced from the interim Business Opportunity Rule.
As noted above, the interim Business Opportunity Rule requires an
extensive list of suits that must be disclosed including those
involving allegations of fraud, unfair or deceptive business practices,
embezzlement, fraudulent conversion, misappropriation of property, and
restraint of trade. Business opportunity sellers also must disclose
suits filed against them involving the business opportunity
relationship. 16 CFR at 437.1(a)(4). In contrast, the proposed Rule's
lawsuit disclosure requirements are limited to suits for
misrepresentation, fraud, or unfair or deceptive business practices
only.
2. Incorporation of existing materials
The RPBOR also reduces collection and dissemination costs by
permitting sellers to reference in their disclosure documents materials
already in the possession of the seller. For example, a seller need not
repeat its refund policy in the text of the disclosure document, but
may attach its contract or brochures, or other materials that already
provide the necessary details.
3. Use of electronic dissemination of information
The RPBOR defines the term ``written'' to include electronic media.
Accordingly, all business opportunities covered by the RPBOR are
permitted to use the Internet and other electronic media to furnish
disclosure documents. Allowing this distribution method could greatly
reduce sellers' compliance costs over the long run, especially costs
associated with printing and distributing disclosure documents. As a
result of this proposal, the Commission expects sellers' compliance
costs will decrease substantially over time.
4. Use of computerized data collection technology
Finally, because of advances in computerized data collection
technology, the Commission anticipates that the costs of collecting
information and recordkeeping requirements imposed by the RPBOR will be
minimal. For example, a seller can easily maintain a spreadsheet of its
purchasers, which can be sorted by location. This would enable a seller
to comply easily with the proposed reference disclosure requirement (at
least 10 prior purchasers in the last
[[Page 16130]]
three years who are located nearest the prospective purchaser, or, if
there are not 10 prior purchasers, then all prior purchasers). In the
alternative, the RPBOR permits a seller to maintain a national list of
purchasers.
As a result of these proposals, the Commission estimates that the
3,050 business opportunity sellers will require between three hours and
five hours each to develop a Rule-compliant disclosure document.\226\
On the lower end, the staff estimates that for existing businesses that
have not been covered by the interim Business Opportunity Rule but will
be covered by the RPBOR, such as work-at-home schemes, the time
required for making a new disclosure document is approximately 5 hours.
By contrast, businesses that have been covered by the interim Business
Opportunity Rule will already have a disclosure document which will
just need updating to meet the requirements of the RPBOR. The staff
estimates that these 2,500 businesses will likely need only 3 hours to
perform the necessary updating to the disclosure document. Therefore,
the hours required to develop a disclosure document in the first year
would be approximately 10,250 ((550 x 5 hours) + (2,500 x 3 hours)). In
addition, staff estimates these entities will require between one and
two hours to file and store records per year, for a total of 6,100
hours (3,050 x 2 hours). Staff assumes that in many instances an
attorney likely would prepare or update the disclosure document, at an
estimated hourly rate of $250. The Commission estimates that the total
number of hours initially to comply with the Rule would be
approximately 16,350 (10,250 disclosure-related hours + 6,100
recordkeeping hours), at a total cost of $4,087,500 (16,350 x $250).
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\226\ While commenters from the MLM industry argue that the
costs of complying would be significantly higher, see supra Section
C.2.a., their estimates are based on assumptions that would not
apply to more narrow field of the business opportunities that are
within the scope of the proposed Rule.
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FTC staff expects that the annual burden will diminish after the
first year to two hours to prepare disclosures and between one and two
hours of recordkeeping, resulting in approximately 12,200 hours per
year (3,050 x 4 hours) or fewer, for a total cost of $3,050,000 (12,200
hours x $250). To the extent that disclosure or recordkeeping
obligations are performed by clerical staff, the labor costs initially
and thereafter would be significantly less.
The Commission invites comments that will enable it to:
1. Evaluate whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
utility;
2. Evaluate the accuracy of the Commission's estimate of the burden
of the collection of information, including the validity of the
methodology and assumptions used;
3. Enhance the quality, usefulness, and clarity of the information
to be collected; and
4. Minimize the burden of collection of information on those who
are to respond, including through the use of appropriate automated
electronic, mechanical, or other technological collection techniques,
or other forms of information technology, for example, permitting
electronic submission of responses.
Comments on any proposed filing, recordkeeping, or disclosure
requirements that are subject to paperwork burden review under the
Paperwork Reduction Act should additionally be submitted to: Office of
Information and Regulatory Affairs, Office of Management and Budget,
Attention: Desk Officer for the Federal Trade Commission. Comments
should be submitted via facsimile to (202) 395-6974 because U.S. Postal
Mail is subject to lengthy delays due to heightened security
precautions.
OMB will act on this request for review of the collection of
information contained in these proposed regulations between 30 and 60
days after publication of this document in the Federal Register.
Therefore, a comment to OMB is best assured of having its full effect
if OMB receives the comment within 30 days of publication. This does
not affect the deadline for the public to comment to the FTC on the
proposed regulation.
Section H Regulatory Analysis
Section 22 of the FTC Act, 15 U.S.C. 57b, requires the Commission
to issue a preliminary regulatory analysis when publishing a Notice of
Proposed Rulemaking, but requires the Commission to prepare such an
analysis for a rule amendment proceeding only if it:
(1) estimates that the amendment will have an annual effect on the
national economy of $100,000,000 or more; (2) estimates that the
amendment will cause a substantial change in the cost or price of
certain categories of goods or services; or (3) otherwise determines
that the amendment will have a significant effect upon covered entities
or upon consumers. To the extent that this Document constitutes a
Notice of Proposed Rulemaking, the Commission has set forth in Section
I below, in connection with its Initial Regulatory Flexibility Analysis
(``IRFA'') under the Regulatory Flexibility Act, and has discussed
elsewhere in this Document: (1) the need for and objectives of the
proposed Rule (see IRFA ] 2); (2) a description of reasonable
alternatives that would accomplish the Rule's stated objectives
consistent with applicable law (see IRFA ] 6); and a preliminary
analysis of the benefits and adverse effects of those alternatives (see
id.). The Commission has determined that the proposed amendments to the
Business Opportunity Rule will not have such an annual effect on the
national economy, on the cost or prices of goods or services sold
through business opportunities, or on covered businesses or consumers.
As noted in the Paperwork Reduction Act discussion above, the
Commission staff estimates each business affected by the Rule will
likely incur only minimal compliance costs. Specifically, approximately
3,050 businesses will spend not more than $1,750 (7 hours x $250 each)
to comply with the proposed Rule and not more than $1000 (4 hours x
$250 each) to update the four required disclosures on an annual basis.
These figures reflect a change in the estimated number of affected
businesses, since the estimate now excludes MLM companies. As explained
above, the RPBOR no longer sweeps in MLM companies or their networks of
distributors. To ensure that the Commission has considered all relevant
facts, however, it requests additional comment on these issues.
Section I Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601--612,
requires an agency to provide an IRFA with a proposed rule and a Final
Regulatory Flexibility Analysis (``FRFA'') with the final rule, if any,
unless the agency certifies that the rule will not have a significant
economic impact on a substantial number of small entities. See 5 U.S.C.
603--605. The FTC does not expect that the RPBOR will have a
significant economic impact on a substantial number of small entities.
The abbreviated disclosure and recordkeeping requirements of the RPBOR
are the minimum necessary to give consumers the information they need
to protect themselves and permit effective enforcement of the rule.
Companies previously covered by the original Franchise Rule and now
covered by the interim Business Opportunity Rule, will experience a
reduction in their compliance burden,
[[Page 16131]]
while companies not previously covered will have minimal new disclosure
obligations. As such, the economic impact of the RPBOR will be minimal.
In any event, the burdens imposed on small businesses are likely to be
relatively small, and in the Commission's enforcement experience,
insignificant in comparison to their gross sales and profits.
This document serves as notice to the Small Business Administration
of the agency's certification of no effect. Nonetheless, the Commission
has determined that it is appropriate to publish an IRFA in order to
inquire into the impact of the proposed Rule on small entities.
Therefore, the Commission has prepared the following analysis, based on
the IRFA set forth in the Commission's earlier notice of proposed
rulemaking, after a review of the public comments submitted in response
to that notice and additional information and analysis by Commission
staff.
1. Description of the Reasons that Action by the Agency Is Being
Considered
The Commission's law enforcement experience provides ample evidence
that fraud is pervasive in the sale of many business opportunities
marketed to consumers. Yet, the Commission believes that the current
requirements of the interim Business Opportunity Rule are more
extensive than necessary to protect prospective purchasers of business
opportunities from deception. The pre-sale disclosures provided by the
RPBOR will give consumers the information they need to protect
themselves from fraudulent sales claims, while minimizing the
compliance costs and burdens on sellers.
2. Succinct Statement of the Objectives of, and Legal Basis for, the
Proposed Rule
The objective of the RPBOR is to provide consumers considering the
purchase of a business opportunity with material information they need
to investigate the offering thoroughly so they can protect themselves
from fraudulent claims, while minimizing the compliance burdens on
sellers. The legal basis for the proposed Rule is Section 18 of the FTC
Act, 15 U.S.C. 57a, which authorizes the Commission to promulgate,
modify, and repeal trade regulation rules that define with specificity
acts or practices in or affecting commerce that are unfair or deceptive
within the meaning of Section (5)(a)(1) of the FTC Act, 15 U.S.C.
45(a)(1).
3. Description of and, Where Feasible, Estimate of the Number of Small
Entities to Which the Proposed Rule Will Apply
The RPBOR primarily applies to ``sellers'' of business
opportunities, including vending, rack display, medical billing, and
work-at-home (e.g., craft assembly, envelope stuffing) opportunities.
The Commission believes that many of these sellers fall into the
category of small entities. Determining the precise number of small
entities affected by the RPBOR, however, is difficult due to the wide
range of businesses engaged in business opportunity sales. The staff
estimates that there are approximately 3,050 business opportunity
sellers, including some 2,500 vending machine, rack display, and
related opportunity sellers and 550 work-at-home opportunity sellers.
The previous IRFA estimated a total of 3,200 business opportunity
sellers, including 150 multilevel companies, which are no longer
covered by the proposed rule. Most established and some start-up
business opportunities would likely be considered small businesses
according to the applicable SBA size standards.\227\ The FTC staff
estimates that as many as 70% of business opportunities, as defined by
the Rule, are small businesses. The Commission invites comments and
information on this issue.
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\227\ Since October 2000, SBA size standards have been based on
the North American Industry Classification System (``NAICS''), in
place of the Standard Industrial Classification (``SIC'') system. In
general, a company in a non-manufacturing industry is a small
business if its average annual receipts are $6.5 million or less.
See http://www.sba.gov/size/indexguide.html. Thus, the size standard
for vending machine operators is $6.5 million in annual receipts
(NAICS 454210), and the same size standard applies to other direct
selling establishments (NAICS 454390), marketing consulting services
(NAICS 541613), other management consulting services (NAICS 541618)
and other business support services (NAICS 561499).
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4. Projected Reporting, Recordkeeping and Other Compliance
Requirements, Including an Estimate of the Classes of Small Entities
that Will Be Subject to the Requirement and the Type of Professional
Skills Necessary for Preparation of the Report or Record
The RPBOR imposes disclosure and recordkeeping requirements, within
the meaning of the Paperwork Reduction Act, on the ``sellers'' of
business opportunities and their principals. These requirements are
fewer in number and lesser in extent than requirements currently
applicable to such entities now covered by the interim Business
Opportunity Rule and formerly covered by the original Franchise Rule.
Section 437.2 of the proposed Rule would require ``sellers'' of covered
business opportunities to provide potential purchasers with a one-page
disclosure document, as specified by Section 437.3 and Appendix A, at
least seven calendar days before they sign a contract or pay any money
toward a purchase. If a seller elects to make an earnings claim,
Section 437.4 would require that written substantiation for the claim
be provided to the purchaser in a separate ``earnings claim statement''
document. However, the proposed Rule would not require sellers to make
an earnings claim, and thus any compliance costs incurred in connection
with such claims are strictly optional.
Section 437.6 of the RPBOR prescribes recordkeeping requirements
necessary for effective enforcement of the Rule. Specifically, sellers
of a covered business opportunity, and their principals, must retain
for at least three years the following types of documents: (1) each
materially different version of all documents required by the Rule; (2)
each purchaser's disclosure receipt; (3) each executed written contract
with a purchaser; and (4) all substantiation upon which the seller
relies for each earnings claim made. The RPBOR requires that these
records be made available for inspection by the Commission, but does
not otherwise require production of the records. The Commission is
seeking clearance from the Office of Management and Budget (``OMB'')
for these requirements, and the Commission's Supporting Statement
submitted as part of that process will be made available on the public
record of this rulemaking.
As discussed in section H above, FTC staff estimates that the total
number of hours initially to comply with the Rule would be 16,350, at a
total cost of $4,087,500 (16,350 x $250), or less. FTC staff expects
that the annual burden of complying with the rule will diminish after
the first year, however, to approximately 12,200 hours, at a total cost
of $3,050,000 (12,200 hours x $250). To the extent that disclosure or
recordkeeping obligations are performed by clerical staff, the total
labor costs would be substantially less. The change in these estimates
from the previous IRFA reflect that the total estimated number of
sellers no longer includes multilevel companies.
5. Other Duplicative, Overlapping, or Conflicting Federal Rules
There are no other federal statutes, rules, or policies that would
conflict with the RPBOR, which would amend
[[Page 16132]]
the Commission's interim Business Opportunity Rule, 16 CFR Part 437.1.
The Commission notes, however, that it is aware that 22 states have
statutes specifically governing the sale of business opportunities. The
Commission therefore seeks comment and information about any state
statutes or rules that may conflict with the proposed requirements, as
well as any other state, local, or industry rules or policies that
require covered entities to implement practices that conflict or
comport with the requirements of the RPBOR.
6. Description of Any Significant Alternatives to the Proposed Rule
That Would Accomplish the Stated Objectives of Applicable Statutes and
That Minimize Any Significant Economic Impact of the Proposed Rule on
Small Entities, Including Alternatives Considered, Such as: (1)
Establishment of Differing Compliance or Reporting Requirements or
Timetables That Take Into Account the Resources Available to Small
Entities; (2) Clarification, Consolidation, or Simplification of
Compliance and Reporting Requirements Under the Rule for Such Small
Entities; and (3) Any Exemption From Coverage of the Rule, or Any Part
Thereof, for Such Small Entities
The RPBOR's disclosure and recordkeeping requirements are designed
to impose the minimum burden on all affected business opportunity
sellers, regardless of size. In formulating the RPBOR, the Commission
has taken a number of significant steps to minimize the burdens it
would impose on large and small businesses. These include: (1) limiting
the required pre-sale disclosure to a one-page document, with check
boxes provided to simplify disclosure responses; (2) allowing the
disclosure to refer to information in other existing documents to avoid
needless duplication; (3) permitting the disclosure document itself to
be furnished in electronic form to minimize printing and distribution
costs; and (4) employing specific prohibitions in place of affirmative
disclosures whenever possible. Moreover, because the majority of
sellers covered by the RPBOR are already required to comply with the
Commission's interim Business Opportunity Rule and the business
opportunity laws in 22 states, FTC staff anticipates that the RPBOR
will drastically reduce their current compliance costs, while imposing
exceedingly modest ongoing compliance costs on all covered sellers.
Consequently, the Commission believes that the RPBOR will not have a
significant economic impact upon small businesses.
The RPBOR would require business opportunity sellers to provide
only four affirmative disclosures in a one-page disclosure document.
This is a significant reduction from the 20 disclosures now required by
the Commission's interim Business Opportunity Rule, with which many
business opportunity sellers are now obligated to comply. The RPBOR
limits required disclosures to information about the sellers'
litigation history, refund policy, prior purchaser references, and a
statement about whether the seller makes an earnings claim. Because the
RPBOR does not require sellers to make information about potential
earnings available to potential purchasers, such earnings claims are
entirely optional. Thus, if sellers make no earnings claims whatsoever,
they can avoid the RPBOR's requirement that any person making an
earnings claim provide a potential purchaser with an earnings claim
representation in writing that provides substantiation for the claim.
Thus, the Commission does not believe that the RPBOR will impose a
significant economic impact on a substantial number of small
businesses. Nonetheless, the Commission specifically requests comment
on the question whether the RPBOR imposes a significant impact upon a
substantial number of small entities, and what modifications to the
rule the Commission could make to minimize the burden on small
entities. Moreover, the Commission requests comment on the general
question whether new technology or changes in technology can be used to
reduce the burdens mandated by the Act.
In some situations, the Commission has considered adopting a
delayed effective date for small entities subject to a new regulation
in order to provide them with additional time to come into compliance.
In this case, however, in light of the RPBOR's flexible standard and
modest compliance costs, the Commission believes that small entities
should feasibly be able to come into compliance with the RPBOR by the
proposed effective date, six months following publication of the final
Rule. Nonetheless, the Commission invites comment on whether small
businesses might need additional time to come into compliance and, if
so, why.
In addition, the Commission has the authority to exempt any persons
or classes of persons from the Rule's application pursuant to Section
18(g) of the FTC Act. The Commission therefore requests comment on
whether there are any persons or classes of persons covered by the
RPBOR that it should consider exempting from the Rule's application
pursuant to Section 18(g). However, the Commission notes that the
RPBOR's purpose of protecting consumers against fraud could be
undermined by the granting of a broad exemption to small entities.
7. Questions for Comment to Assist Regulatory Flexibility Analysis
a. Please provide information or comment on the number and type of
small entities affected by the RPBOR. Include in your comment the
number of small entities that will be required to comply with the
RPBOR's disclosure and recordkeeping requirements.
b. Please provide comment on any or all of the provisions in the
RPBOR with regard to: (a) the impact of the provision(s) (including
benefits and costs to implement and comply with the RPBOR or any of its
provisions), if any; and (b) what alternatives, if any, the Commission
should consider, as well as the costs and benefits of those
alternatives, paying specific attention to the effect of the RPBOR on
small entities in light of the above analysis. In particular, please
provide the above information with regard to the disclosure and
recordkeeping provisions of the RPBOR set forth in sections 437.2,
437.3, 437.4, and 437.6, and describe any ways in which the RPBOR could
be modified to reduce any costs or burdens for small entities
consistent with the RPBOR's purpose, and costs to implement and comply
with provisions of the RPBOR, including expenditures of time and money
for: any employee training; attorney, computer programmer or other
professional time; preparing relevant materials (e.g., disclosure
documents); and recordkeeping.
c. Please describe ways in which the RPBOR could be modified to
reduce any costs or burdens on small entities, including whether and
how technological developments could further reduce the costs of
implementing and complying with the RPBOR for small entities.
d. Please provide any information quantifying the economic costs
and benefits of the RPBOR on the entities covered, including small
entities.
e. Please identify any relevant federal, state, or local rules that
may duplicate, overlap or conflict with the RPBOR.
Section J Request for Comments
The Commission invites members of the public to comment on any
issues or concerns they believe are relevant or
[[Page 16133]]
appropriate to the Commission's consideration of the RPBOR. The
Commission requests that factual data upon which the comments are based
be submitted with the comments. In addition to the issues raised above,
the Commission will continue to accept public comment on the specific
questions identified in the Notice of Proposed Rulemaking.\228\
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\228\ 71 FR at 19083 - 87.
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Furthermore, the Commission solicits comment on the following
specific questions.
In response to each of the following questions, please provide: (1)
detailed comment, including data, statistics, consumer complaint
information, and other evidence, regarding the issues addressed in the
question; (2) comment as to whether the proposal does or does not
provide an adequate solution to the problems it is intended to address;
and (3) suggestions for additional changes that might better maximize
consumer protections or minimize the burden on business opportunity
sellers.
1. Proposed section 437.1(c) limits the scope of coverage to
sellers who offer to provide location assistance, account assistance,
or buy-back assistance. Do the enumerated categories of assistance that
are necessary to trigger coverage of the rule adequately cover the
field of business opportunity promoters who are most likely to engage
in fraud? Why or why not? What alternatives, if any, should the
Commission consider? What would be the costs and benefits of each
alternative? The RPBOR covers all business arrangements currently
covered by the interim Business Opportunity Rule, as well as certain
others currently not covered, such as work-at-home offerings (e.g.,
envelope stuffing or craft assembly schemes), and offerings costing
less than $500. Are there other types of offerings not covered by the
interim Business Opportunity Rule that inadvertently may be covered
under the RPBOR? In particular, are the limitations to the RPBOR's
coverage sufficient to keep the rule from covering traditional
distributor relationships? Why or why not? Are there industries where
there are significant numbers of people who work at home and are paid
on a piece-work basis? Would firms that employ such workers become
subject to the provisions of the RPBOR? Why or why not? What
alternatives should the Commission consider to avoid covering
arrangements that should not be covered by the RPBOR?
2. The definition of ``providing locations, outlets, accounts, or
customers'' includes ``otherwise assisting the prospective purchaser in
obtaining his or her own locations, outlets, accounts, or customers.''
Does this language adequately cover all of the business opportunity
arrangements that should be within the scope of the rule? Why or why
not? Will the inclusion of ``otherwise assisting'' in the definition
cause traditional product distribution arrangements, educational
institutions, or how-to books to be subject to the proposed Rule? Will
it result in the inclusion of multi-level marketing relationships that
would otherwise not be covered? Why or why not? How could the language
be refined to achieve the proper scope?
3. The one-page disclosure document set forth in Appendix A is
intended to provide prospective purchasers with material information
with which to make an informed investment decision. The Commission has
retained an expert to evaluate the proposed form to ensure that it
appropriately conveys to the consumer information that is material to
the transaction. Can the overall presentation of the information in the
one-page disclosure document be improved to make it more useful and
understandable? Are there specific sections that can be improved by
simplifying the presentation to make it easier for prospective
purchasers to understand? How could the presentation be improved? What
would be the costs and benefits of each alternative? Please submit
quantitative or qualitative analysis to support specific
recommendations.
4. Proposed section 437.3(a)(3) would require sellers to furnish
certain litigation information. Specifically, the seller would disclose
information about itself, as well as any affiliates and prior
businesses, any of the seller's officers, directors, and sales
managers, but not of sales employees. Does this provision adequately
capture the types of individuals whose litigation should be disclosed?
Why or why not? What alternative language, if any, should the
Commission consider? What would be the costs and benefits of each
alternative?
5. Proposed section 437.3(a)(6) would enable a seller to furnish
prospective purchasers with a national list of prior purchasers. Is
this a viable option? Why or why not? Under what circumstances should
the Rule permit a seller to post a national list of purchasers on its
website? What protections should be put in place to limit access to the
list? What protections might be sufficient to prevent those who merely
want to sell fraudulent business opportunities from accessing such a
list? What other options, if any, should the Commission consider? Would
these options enable the seller to select only those prior purchasers
who are successful or who otherwise would give a favorable report on
the seller? What would be the costs and benefits of each alternative?
6. Proposed Sections 437.4(a)(4)(v) and 437.4(b)(3)(ii) would
require business opportunity sellers who make earnings claims to
disclose ``the number and percentage of all persons who purchased the
business opportunity prior to the ending date [of the period when the
represented earnings were achieved] who achieved at least the stated
level of earnings. Does this requirement create difficulties for a
business opportunity seller who is attempting to inform consumers
accurately of their likely experience if they purchase the business
opportunity being offered? Is such a disclosure going to be useful to
consumers who are considering the purchase of the business opportunity?
Why or why not? Are there alternative approaches--for example, limiting
the set of purchasers to be included in the percentage calculation--
that would limit the difficulties? How would any such proposals affect
the usefulness of the resulting information to prospective purchasers?
7. Proposed section 437.4(a)(4)(vi) would require sellers who make
earnings claims to disclose ``any characteristics of the purchasers who
achieved at least the represented level of earnings, such as their
location, that may differ materially from the characteristics of the
prospective purchasers being offered the business opportunity.'' Does
this provision adequately capture the relevant earnings information
that should be disclosed? Why? What alternative language, if any,
should the Commission consider? What would be the costs and benefits of
each alternative?
8. Proposed section 437.7 identifies two categories of franchises
that are exempt from the requirements of the RPBOR. Is the exemption
overly broad or overly narrow? Why? What alternative language, if any,
should the Commission consider?
List of Subjects in 16 CFR Part 437
Reporting and recordkeeping requirements, Trade practices.
Section K Text of Proposed Rule
For the reasons set forth in the preamble, the Federal Trade
Commission proposes to amend 16 C.F.R. chapter I by adding part 437 to
read as follows:
[[Page 16134]]
PART 437--BUSINESS OPPORTUNITY RULE
Sec.
437.1 Definitions.
437.2 The obligation to furnish written documents.
437.3 Disclosure document.
437.4 Earnings claims.
437.5 Other prohibited practices.
437.6 Record retention.
437.7 Franchise exemption.
437.8 Outstanding orders; preemption.
437.9 Severability.
Appendix A to Part 437: Business Opportunity Disclosure Document
Authority: 15 U.S.C. 41-58.
Sec. 437.1 Definitions.
The following definitions shall apply throughout this part:
(a) Action means a criminal information, indictment, or proceeding;
a civil complaint, cross claim, counterclaim, or third-party complaint
in a judicial action or proceeding; arbitration; or any governmental
administrative proceeding, including, but not limited to, an action to
obtain or issue a cease and desist order, and an assurance of voluntary
compliance.
(b) Affiliate means an entity controlled by, controlling, or under
common control with a business opportunity seller.
(c) Business opportunity means:
(1) A commercial arrangement in which the seller solicits a
prospective purchaser to enter into a new business; and
(2) The prospective purchaser makes a required payment; and
(3) The seller, expressly or by implication, orally or in writing,
represents that the seller or one or more designated persons will:
(i) Provide locations for the use or operation of equipment,
displays, vending machines, or similar devices, on premises neither
owned nor leased by the purchaser; or
(ii) Provide outlets, accounts, or customers, including, but not
limited to, Internet outlets, accounts, or customers, for the
purchaser's goods or services; or
(iii) Buy back any or all of the goods or services that the
purchaser makes, produces, fabricates, grows, breeds, modifies, or
provides, including but not limited to providing payment for such
services as, for example, stuffing envelopes from the purchaser's home.
(d) Designated person means any person, other than the seller,
whose goods or services the seller suggests, recommends, or requires
that the purchaser use in establishing or operating a new business.
(e) Disclose or state means to give information in writing that is
clear and conspicuous, accurate, concise, and legible.
(f) Earnings claim means any oral, written, or visual
representation to a prospective purchaser that conveys, expressly or by
implication, a specific level or range of actual or potential sales, or
gross or net income or profits. Earnings claims include, but are not
limited to:
(1) Any chart, table, or mathematical calculation that demonstrates
possible results based upon a combination of variables; and
(2) Any statements from which a prospective purchaser can
reasonably infer that he or she will earn a minimum level of income
(e.g., ``earn enough to buy a Porsche,'' ``earn a six-figure income,''
or ``earn your investment back within one year'').
(g) Exclusive territory means a specified geographic or other
actual or implied marketing area in which the seller promises not to
locate additional purchasers or offer the same or similar goods or
services as the purchaser through alternative channels of distribution.
(h) General media means any instrumentality through which a person
may communicate with the public, including, but not limited to,
television, radio, print, Internet, billboard, website, and commercial
bulk email.
(i) New business means a business in which the prospective
purchaser is not currently engaged, or a new line or type of business.
(j) Person means an individual, group, association, limited or
general partnership, corporation, or any other entity.
(k) Prior business means:
(1) A business from which the seller acquired, directly or
indirectly, the major portion of the business' assets, or
(2) Any business previously owned or operated by the seller, in
whole or in part, by any of the seller's officers, directors, sales
managers, or by any other individual who occupies a position or
performs a function similar to that of an officer, director, or sales
manager of the seller.
(l) Providing locations, outlets, accounts, or customers means
furnishing the prospective purchaser with existing or potential
locations, outlets, accounts, or customers; requiring, recommending, or
suggesting one or more locators or lead generating companies; providing
a list of locator or lead generating companies; collecting a fee on
behalf of one or more locators or lead generating companies; offering
to furnish a list of locations; or otherwise assisting the prospective
purchaser in obtaining his or her own locations, outlets, accounts, or
customers.
(m) Purchaser means a person who buys a business opportunity.
(n) Quarterly means as of January 1, April 1, July 1, and October
1.
(o) Required payment means all consideration that the purchaser
must pay to the seller or an affiliate, either by contract or by
practical necessity, as a condition of obtaining or commencing
operation of the business opportunity. Such payment may be made
directly or indirectly through a third-party. A required payment does
not include payments for the purchase of reasonable amounts of
inventory at bona fide wholesale prices for resale or lease.
(p) Seller means a person who offers for sale or sells a business
opportunity.
(q) Written or in writing means any document or information in
printed form or in any form capable of being downloaded, printed, or
otherwise preserved in tangible form and read. It includes: type-set,
word processed, or handwritten documents; information on computer disk
or CD-ROM; information sent via email; or information posted on the
Internet. It does not include mere oral statements.
Sec. 437.2 The obligation to furnish written documents.
In connection with the offer for sale, sale, or promotion of a
business opportunity, it is a violation of this Rule and an unfair or
deceptive act or practice in violation of Section 5 of the Federal
Trade Commission Act (``FTC Act'') for any seller to fail to furnish a
prospective purchaser with the material information required by
Sec. Sec. 437.3(a) and 437.4(a) of this part in writing at least seven
calendar days before the earlier of the time that the prospective
purchaser:
(a) Signs any contract in connection with the business opportunity
sale; or
(b) Makes a payment or provides other consideration to the seller,
directly or indirectly through a third party.
Sec. 437.3 Disclosure document.
In connection with the offer for sale, sale, or promotion of a
business opportunity, it is a violation of this Rule and an unfair or
deceptive act or practice in violation of Section 5 of the FTC Act, for
any seller to:
(a) Fail to disclose to a prospective purchaser the following
material information in a single written document in the form and using
the language set forth in Appendix A to this part:
(1) Identifying information. State the name, business address, and
telephone number of the seller, the name of the salesperson offering
the opportunity,
[[Page 16135]]
and the date when the disclosure document is furnished to the
prospective purchaser.
(2) Earnings claims. If the seller makes an earnings claim, check
the ``yes'' box and attach the earnings statement required by Sec.
437.4. If not, check the ``no'' box.
(3) Legal actions.
(i) If any of the following persons has been the subject of any
civil or criminal action for misrepresentation, fraud, securities law
violations, or unfair or deceptive practices within the 10 years
immediately preceding the date that the business opportunity is
offered, check the ``yes'' box:
(A) The seller;
(B) Any affiliate or prior business of the seller; or
(C) Any of the seller's officers, directors, sales managers, or any
individual who occupies a position or performs a function similar to an
officer, director, or sales manager of the seller.
(ii) If the ``yes'' box is checked, disclose all such actions in an
attachment to the disclosure document. State the full caption of each
action (names of the principal parties, case number, full name of
court, and filing date).
(iii) If there are no actions to disclose, check the ``no'' box.
(4) Cancellation or refund policy. If the seller offers a refund or
the right to cancel the purchase, check the ``yes'' box. If so, state
the terms of the refund or cancellation policy in an attachment to the
disclosure document. If no refund or cancellation is offered, check the
``no'' box.
(5) References.
(i) State the name, city and state, and telephone number of all
purchasers who purchased the business opportunity within the last three
years. If more than 10 purchasers purchased the business opportunity
within the last three years, the seller may limit the disclosure by
stating the name, city and state, and telephone number of at least the
10 purchasers within the past three years who are located nearest to
the prospective purchaser's location. Alternatively, a seller may
furnish a prospective buyer with a list disclosing all purchasers
nationwide within the last three years. If choosing this option, insert
the words ``See Attached List'' without removing the list headings or
the numbers 1 through 10, and attach a list of the references to the
disclosure document.
(ii) Clearly and conspicuously, and in immediate conjunction with
the list of references, state the following: ``If you buy a business
opportunity from the seller, your contact information can be disclosed
in the future to other buyers.''
(6) Receipt. Attach a duplicate copy of the disclosure page to be
signed and dated by the purchaser. The seller may inform the
prospective purchaser how to return the signed receipt (for example, by
sending to a street address, email address, or facsimile telephone
number).
(b) Fail to update the disclosures required by paragraph (a) of
this section at least quarterly to reflect any changes in the required
information, including, but not limited to, any changes in the seller's
refund or cancellation policy, or the list of references; provided,
however, that until a seller has 10 purchasers, the list of references
must be updated monthly.
Sec. 437.4 Earnings claims.
In connection with the offer for sale, sale, or promotion of a
business opportunity, it is a violation of this Rule and an unfair or
deceptive act or practice in violation of Section 5 of the FTC Act, for
the seller to:
(a) Make any earnings claim to a prospective purchaser, unless the
seller:
(1) Has a reasonable basis for its claim at the time the claim is
made;
(2) Has in its possession written materials that substantiate its
claim at the time the claim is made;
(3) Makes the written substantiation available upon request to the
prospective purchaser and to the Commission; and
(4) Furnishes to the prospective purchaser an earnings claim
statement. The earnings claim statement shall be a single written
document and shall state the following information:
(i) The title ``EARNINGS CLAIM STATEMENT REQUIRED BY LAW'' in
capital, bold type letters;
(ii) The name of the person making the earnings claim and the date
of the earnings claim;
(iii) The earnings claim;
(iv) The beginning and ending dates when the represented earnings
were achieved;
(v) The number and percentage of all persons who purchased the
business opportunity prior to the ending date in paragraph (a)(4)(iv)
of this section who achieved at least the stated level of earnings;
(vi) Any characteristics of the purchasers who achieved at least
the represented level of earnings, such as their location, that may
differ materially from the characteristics of the prospective
purchasers being offered the business opportunity; and
(vii) A statement that written substantiation for the earnings
claim will be made available to the prospective purchaser upon request.
(b) Make any earnings claim in the general media, unless the
seller:
(1) Has a reasonable basis for its claim at the time the claim is
made;
(2) Has in its possession written material that substantiates its
claim at the time the claim is made;
(3) States in immediate conjunction with the claim:
(i) The beginning and ending dates when the represented earnings
were achieved; and
(ii) The number and percentage of all persons who purchased the
business opportunity prior to the ending date in paragraph (b)(3)(i) of
this section who achieved at least the stated level of earnings.
(c) Disseminate industry financial, earnings, or performance
information unless the seller has written substantiation demonstrating
that the information reflects the typical or ordinary financial,
earnings, or performance experience of purchasers of the business
opportunity being offered for sale.
(d) Fail to notify any prospective purchaser in writing of any
material changes affecting the relevance or reliability of the
information contained in an earnings claim statement before the
prospective purchaser signs any contract or makes a payment or provides
other consideration to the seller, directly or indirectly, through a
third party.
Sec. 437.5 Other prohibited practices.
In connection with the offer for sale, sale, or promotion of a
business opportunity, it is a violation of this part and an unfair or
deceptive act or practice in violation of Section 5 of the FTC Act for
any seller, directly or indirectly through a third party, to:
(a) Disclaim, or require a prospective purchaser to waive reliance
on, any statement made in any document or attachment that is required
or permitted to be disclosed under this Rule;
(b) Make any claim or representation, orally, visually, or in
writing, that is inconsistent with or contradicts the information
required to be disclosed by Sec. Sec. 437.3 (basic disclosure
document) and 437.4 (earnings claims document) of this Rule;
(c) Include in any disclosure document or earnings claim statement
any materials or information other than what is explicitly required or
permitted by this Rule. For the sole purpose of enhancing the
prospective purchaser's ability to maneuver through an electronic
version of a disclosure document or earnings statement, the
[[Page 16136]]
seller may include scroll bars and internal links. All other features
(e.g., multimedia tools such as audio, video, animation, or pop-up
screens) are prohibited;
(d) Misrepresent the amount of sales, or gross or net income or
profits a prospective purchaser may earn or that prior purchasers have
earned;
(e) Misrepresent that any governmental entity, law, or regulation
prohibits a seller from:
(1) furnishing earnings information to a prospective purchaser; or
(2) disclosing to prospective purchasers the identity of other
purchasers of the business opportunity;
(f) Fail to make available to prospective purchasers, and to the
Commission upon request, written substantiation for the seller's
earnings claims;
(g) Misrepresent how or when commissions, bonuses, incentives,
premiums, or other payments from the seller to the purchaser will be
calculated or distributed;
(h) Misrepresent the cost, or the performance, efficacy, nature, or
central characteristics of the business opportunity or the goods or
services offered to a prospective purchaser;
(i) Misrepresent any material aspect of any assistance offered to a
prospective purchaser;
(j) Misrepresent the likelihood that a seller, locator, or lead
generator will find locations, outlets, accounts, or customers for the
purchaser;
(k) Misrepresent any term or condition of the seller's refund or
cancellation policies;
(l) Fail to provide a refund or cancellation when the purchaser has
satisfied the terms and conditions disclosed pursuant to
Sec. 437.3(a)(4);
(m) Misrepresent a business opportunity as an employment
opportunity;
(n) Misrepresent the terms of any territorial exclusivity or
territorial protection offered to a prospective purchaser;
(o) Assign to any purchaser a purported exclusive territory that,
in fact, encompasses the same or overlapping areas already assigned to
another purchaser;
(p) Misrepresent that any person, trademark or service mark holder,
or governmental entity, directly or indirectly benefits from, sponsors,
participates in, endorses, approves, authorizes, or is otherwise
associated with the sale of the business opportunity or the goods or
services sold through the business opportunity;
(q) Misrepresent that any person:
(1) Has purchased a business opportunity from the seller or has
operated a business opportunity of the type offered by the seller; or
(2) Can provide an independent or reliable report about the
business opportunity or the experiences of any current or former
purchaser.
(r) Fail to disclose, with respect to any person identified as a
purchaser or operator of a business opportunity offered by the seller:
(1) Any consideration promised or paid to such person.
Consideration includes, but is not limited to, any payment, forgiveness
of debt, or provision of equipment, services, or discounts to the
person or to a third party on the person's behalf; or
(2) Any personal relationship or any past or present business
relationship other than as the purchaser or operator of the business
opportunity being offered by the seller.
Sec. 437.6 Record retention.
To prevent the unfair and deceptive acts or practices specified in
this Rule, business opportunity sellers and their principals must
prepare, retain, and make available for inspection by Commission
officials copies of the following documents for a period of three
years:
(a) Each materially different version of all documents required by
this Rule;
(b) Each purchaser's disclosure receipt;
(c) Each executed written contract with a purchaser; and
(d) All substantiation upon which the seller relies for each
earnings claim from the time each such claim is made.
Sec. 437.7 Franchise exemption.
The provisions of this Rule shall not apply to any business
opportunity that constitutes a ``franchise,'' as defined in the
Franchise Rule, 16 CFR Part 436, provided however, that the provisions
of this Rule shall apply to any such franchise if it is exempted from
the provisions of Part 436 because, either
(a) Under Sec. 436.8(a)(1), the total of the required payments or
commitments to make a required payment, to the franchisor or an
affiliate that are made any time from before to within six months after
commencing operation of the franchisee's business is less than $500, or
(b) Under Sec. 436.8(a)(7), there is no written document
describing any material term or aspect of the relationship or
arrangement.
Sec. 437.8 Outstanding orders; preemption.
(a) If an outstanding FTC or court order applies to a person, but
imposes requirements that are inconsistent with any provision of this
regulation, the person may petition the Commission to amend the order.
In particular, business opportunities required by FTC or court order to
follow the Franchise Rule, 16 CFR Part 436, may petition the Commission
to amend the order so that the business opportunity may follow the
provisions of this part.
(b) The FTC does not intend to preempt the business opportunity
sales practices laws of any state or local government, except to the
extent of any conflict with this part. A law is not in conflict with
this Rule if it affords prospective purchasers equal or greater
protection, such as registration of disclosure documents or more
extensive disclosures. All such disclosures, however, must be made in a
separate state disclosure document.
Sec. 437.9 Severability.
The provisions of this part are separate and severable from one
another. If any provision is stayed or determined to be invalid, it is
the Commission's intention that the remaining provisions shall continue
in effect.
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BILLING CODE 6750-01-C
[[Page 16138]]
By direction of the Commission.
Donald S. Clark
Secretary
Attachment A
Cited NPR Commenters
Avon Products, Inc. (``Avon'')
American Society of Travel Agents, Inc. (``ASTA'')
Amsoil, Inc (``Amsoil'')
Babener and Associates (``Babener'')
Carico International (``Carico'')
Chadbourne & Parke LLP, (``Chadbourne'')
Chamber of Commerce of the United States of America (``CC USA'')
Consumer Awareness Institute (``CAI'')
The Cosmetic, Toiletry and Fragrance Association (``CTFA'')
Direct Selling Association (``DSA'')
Freelife International (``Freelife'')
Venable, LLP (``Venable'')
Haynes & Boone, LLP (``Haynesboone'') Herbalife International of
America (``Herbalife'')
Home Interiors & Gifts Inc. (``HIG'')
Independent Bakers Association (``IBA'')
International Business Owners Ass'n Int'l, (``IBOAI'')
Larkin Hoffman Daly & Lindgren Ltd. (``LHD&L'')
Maclay Murray and Spens LLP (``MMS'')
Mary Kay, Inc. (``Mary Kay'')
Melaleuca, Inc. (``Melaleuca'')
MLM Distributor Rights Ass'n (MLM DRA)
Multilevel Marketing International Association (``MLMIA'')
National Association of Consumer Agency Administrators (``NACAA'')
National Black Chamber of Commerce (``NBCC'')
National Consumers League (``NCL'')
Newspaper Association of America (``NAA'')
Pampered Chef, Ltd. (``Pampered Chef'')
Pre-Paid Legal Services, Inc. (``Pre-Paid Legal'')
Primerica Financial Services, Inc., (``Primerica'')
Plumbing Manufacturers Institute (``PMI'')
Professional Association for Network Marketing (``PANM'')
Pyramid Scheme Alert (``PSA'')
Quixtar, Inc. (``Quixtar'')
Shaklee Corporation (``Shaklee'')
Snell & Wilmer (``Snell'')
Sonnenschein Nath & Rosenthal LLP (``Sonnenschein'')
Southern Progress Corporation (``SPC'')
Success In Action (``SIA'')
Shure Pets (``Shure'')
Symmetry Corporation (``Symmetry'')
Synergy Worldwide (``Synergy'')
The Timberland Co. (``Timberland'')
United States Department of Justice, Office of Consumer Litigation
(``DOJ'')
Venable LLP (``Venable'')
World Association of Persons with disAbilities, Inc. (``WAPAI'')
Xango, LLC (``Xango'')
[FR Doc. E8-6059 Filed 3-25-08: 8:45 am]
BILLING CODE 6750-01-S