Business Opportunity Rule

Federal RegisterApr 12, 2006

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FEDERAL TRADE COMMISSION

16 CFR Part 437

Business Opportunity Rule

AGENCY:

Federal Trade Commission.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

The Federal Trade Commission (the “Commission” or “FTC”) is commencing a rulemaking to promulgate a trade regulation rule entitled “The Business Opportunity Rule” (or “the Rule”), based upon the comments received in response to an Advance Notice of Proposed Rulemaking (“ANPR”) and other information discussed in this notice. The proposed Business Opportunity Rule would prohibit business opportunity sellers from failing to furnish prospective purchasers with material information needed to combat fraud and would prohibit other acts or practices that are unfair or deceptive within the meaning of section 5 of the Federal Trade Commission Act (“FTC Act”).

DATES:

Written comments must be received on or before June 16, 2006. Rebuttal comments must be received on or before July 7, 2006.

ADDRESSES:

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 W), 600 Pennsylvania Avenue, NW., Washington, DC 20580. 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. 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).

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).

Comments filed in electronic form should be submitted by clicking on the following weblink:

https://secure.commentworks.com/ftc-bizopNPR/

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

https://secure.commentworks.com/ftc-bizopNPR/

weblink. If this notice appears at

http://www.regulations.gov,

you may also file an electronic comment through that Web site. The Commission will consider all comments that regulations.gov forwards to it. You may also visit the FTC Web site at

http://www.ftc.gov/opa/2006/04/newbizopprule.htm

to read the 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. All timely and responsive public comments, whether filed in paper or electronic form, will be considered by the Commission, and will be available to the public on the FTC Web site, to the extent practicable, at

http://www.ftc.gov/os/publiccomments.htm.

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 Web site. 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:

Steven Toporoff (202) 326-3135, or Craig Tregillus (202) 326-2970, Division of Marketing Practices, Room 238, Bureau of Consumer Protection, Federal Trade Commission, 600 Pennsylvania Avenue, NW., Washington, DC 20580.

SUPPLEMENTARY INFORMATION:

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 K of this notice. The comment period will remain open until June 16, 2006. To the extent practicable, all comments will be available on the public record and placed on the Commission's Web site:

http://www.ftc.gov/os/publiccomments.htm.

After the close of the comment period, the record will remain open until July 7, 2006, for rebuttal comments. If necessary, the Commission also will hold hearings with cross-examination and post-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 June 16, 2006. 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 July 7, 2006. 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 Notice of Proposed Rulemaking (“NPR”) 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).

1. FTC Regulation of Franchising and Business Opportunity Ventures

In the 1970s, 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.

Based upon the original rulemaking record, the Commission found that franchise and business opportunity fraud was widespread, causing serious economic harm to consumers. To prevent fraudulent practices in the sale of franchises and business opportunities, the Commission adopted a pre-sale disclosure rule.

16 CFR part 436.

See also

Statement of Basis and Purpose (“SBP”), 43 FR 59614 (Dec. 21, 1978).

The Franchise Rule does not purport to regulate the substantive terms of a franchise or business opportunity contract. Rather, it is designed to prevent fraud by prohibiting sellers from failing to disclose material information to prospective buyers. The Franchise Rule is posited on the notion that a fully informed consumer can determine whether a particular offering is in his or her best interest.

The Franchise Rule requires extensive disclosures, including information about the seller;

the business background of its principals and their litigation and bankruptcy histories;

the terms and conditions of the offer;

statistical analyses of existing franchised and company-owned outlets;

prior purchasers, including the names and addresses of at least 10 purchasers nearest the prospective buyer;

and audited financial statements.

Additional disclosure and substantiation provisions apply if the seller chooses to make any financial performance representations.

16 CFR at 436.1(a)(1) and (3).

16 CFR at 436.1(a)(2)-(5).

16 CFR at 436.1(a)(7)-(15) and (17)-(18).

16 CFR at 436.1(a)(16).

16 CFR at 436.1(a)(20).

16 CFR at 436.1(b)-(c) and (e).

The Commission recognized that requiring these extensive disclosures would likely impose significant compliance costs on covered businesses. It therefore sought to strike the proper balance between prospective purchasers' need for pre-sale disclosure and the burden imposed on those selling business arrangements. As a result of this balancing, the Commission limited the scope of the Franchise Rule's coverage in three significant ways.

First, the Franchise Rule covers only those opportunities that require a buyer to make a payment of at least $500 within the first six months of operation.

In transactions where a prospective purchaser may incur high financial losses if the seller withholds material information, the benefit for purchasers of the Rule's pre-sale disclosure requirements outweighs the cost to sellers of making those disclosures. By contrast, when the required investment to purchase a business opportunity is comparatively small, prospective purchasers face a relatively small financial risk. In such circumstances, compliance costs may outweigh the benefits of pre-sale disclosure. Therefore, the Franchise Rule does not reach opportunities that charge lower fees.

16 CFR at 436.2(a)(2) and (a)(3)(iii). In the SBP, the Commission noted that “[w]here a franchisee makes no significant investment in the franchise business, he assumes only a limited risk, and the protection of the rule is inappropriate.” 43 FR at 59704.

See also

Final Interpretive Guides (“Interpretive Guides”) accompanying the Franchise Rule: “The Commission's policy determination [is that] a significant financial investment is a necessary element of a franchise.” Interpretive Guides, 44 FR 49966, 49968 (August 24, 1978).

Nevertheless, deceptive and unfair conduct by a business opportunity seller falling below the Franchise Rule's $500 threshold may constitute a violation of section 5 of the FTC Act.

E.g., FTC

Med. Billers Network, Inc.,

No. 05 CIV 2014 (RJH) (S.D.N.Y. 2005) ($200-295 fee);

FTC

Kamaco Int'l,

No. CV 02-04566 LGB (RNBx) (C.D. Cal. 2002) ($42 fee);

FTC

Healthcare Claims Network,

No. 2:02-CV-4569 MMM (AMWx) (C.D. Cal. 2002) ($485 fee);

FTC

Stuffingforcash.com, Corp.,

No. 92 C 5022 (N.D. Ill. 2002) ($45 fee);

FTC

Medicor LLC,

No. CV01-1896 (CBM) (C.D. Cal. 2001) ($375 fee);

FTC

SkyBiz.com,

No. 01-CV-0396-EA (X) (N.D. Okla. 2001) ($125 fee).

Second, the “inventory exemption” excludes certain types of payments from the Rule's $500 minimum cost threshold. The “inventory exemption” is the franchise industry's shorthand term for the Commission's determination that, as a matter of policy, voluntary purchases of reasonable amounts of inventory at bona fide wholesale prices for resale do not count toward the required threshold payment.

An important consequence of this policy determination is to eliminate from Franchise Rule coverage many pyramid marketing plans because the participants in such plans typically do not make a required payment of or exceeding $500, but instead make voluntary purchases of inventory in reasonable amounts and at bona fide wholesale prices for resale.

Interpretive Guides, 44 FR at 49967.

E.g., FTC

Trek Alliance, Inc.,

No. 02-9270 SJL (AJWx) (C.D. Cal. 2002);

FTC

Equinox, Int'l,

No. CV-S-99-0969-JBR-RLJ (D. Nev. 1999).

Third, the Commission focused the Franchise Rule on the types of business opportunities that the record showed were likely to result in significant purchaser injury. The record showed that vending machines, rack displays, and similar opportunities frequently were sold through deception. A feature common to these types of schemes is the promise of assistance in securing locations or accounts.

Thus, the Commission incorporated this characteristic into the Rule's definitional elements to ensure coverage of demonstrably injurious schemes. Other forms of assistance that business opportunity sellers frequently offer—such as training

and the buy-back and resale of goods assembled by the purchaser (an element of many craft assembly opportunities)

—do not bring a business opportunity within the scope of the Franchise Rule's coverage.

16 CFR at 436.2(a)(1)(ii)(B)(1)-(3).

E.g., FTC

Academic Guidance Serv., Inc.,

No. 92-3001 (AET) (D. N.J. 1992).

E.g., FTC

Misty Stafford,

No. 3: CV 05-0215 (M.D. Pa. 2005);

FTC

USS Elder Enter. Inc.,

No. SACV-04-1039 AHS (ANx) (C.D. Cal. 2004);

FTC

Holiday Magic,

No. C 93-4038 VRW (N.D. Cal. 1994).

In addition to these limits on the scope of the Franchise Rule's coverage—driven by balancing prospective purchasers' need for pre-sale disclosure against the burden imposed on business opportunity sellers—another aspect of the Rule's language further limits the Rule's scope of coverage. Specifically, the Rule provides that a business opportunity is covered only if the purchaser of the opportunity sells goods or services directly to end-users other than the business opportunity seller.

The effect of this limitation is to exclude most work-at-home opportunities—such as envelope stuffing and craft assembly ventures—from Franchise Rule coverage. In those opportunities, the purchaser typically works directly for the seller or produces various goods for the seller, who then purportedly distributes them to end-users.

16 CFR at 436.2(a)(1)(ii)(A)(1)-(3).

E.g., FTC

Misty Stafford,

No. 3: CV 05-0215 (M.D. Pa. 2005);

FTC

Sun Ray Trading, Inc.,

No. 05-20402 CIV-Seitz/Bandstra (S.D. Fla. 2005).

The proposed Business Opportunity Rule calls for streamlined disclosures that, compared to the Franchise Rule, substantially reduce the compliance burden. Therefore, the kinds of limits written into the Franchise Rule are not necessary to achieve an appropriate balance between prospective purchasers' need for pre-sale disclosure and the burden imposed on business opportunity sellers. Accordingly, the proposed Rule has no minimum cost threshold, no inventory exemption, and no limit on scope based on the type of assistance promised as part of the offer. Nor is the coverage of the proposed Rule limited to transactions where the purchaser of the opportunity sells goods or services directly to end-users other than the business opportunity seller. In short, the scope of coverage of the proposed Rule is much broader than

that of the Franchise Rule, while the compliance burden is much lighter.

2. Franchise Rule Review

In 1995, the Commission conducted a regulatory review of the Franchise Rule to ensure that it continues to serve a useful purpose.

One issue that the Commission explored in that proceeding was the application of the Franchise Rule to the sale of business opportunities. Specifically, the Commission noted that although the Franchise Rule applied to certain business opportunities, it lacked a clear definition of the term “business opportunity.” Accordingly, the Commission solicited comment on an appropriate definition.

In addition, the Commission asked whether such a definition should include business opportunities not covered by the Franchise Rule, such as “multilevel marketing, seller assisted market plans, work-at-home plans, and certain distributorships and licenses.”

Rule Review, 60 FR 17656 (April 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 is attached as Attachment A.

Rule Review, 60 FR at 17656-658 (Question 13).

Rule Review, 60 FR at 17658 (Question 13b).

The Commission also inquired whether the Franchise Rule's extensive disclosure requirements are well-suited to business opportunity sales and whether the Franchise Rule imposes unnecessary compliance costs on both business opportunity sellers and buyers. For example, certain Franchise Rule disclosures—such as site selection and approval and public figure involvement—arguably are more likely to be important to franchise investors than business opportunity purchasers. 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 because they are unnecessary in the business opportunity context and if any additional material disclosures should be required.

Rule Review, 60 FR at 17658 (Question 14).

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 regulations. 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. To that end, it published an Advance Notice of Proposed Rulemaking, as described in the next section.

3. Advance Notice of Proposed Rulemaking

In 1997, the Commission published an Advance Notice of Proposed Rulemaking (“ANPR”) in the

Federal Register

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,”

the types of business opportunities that are known to engage in deceptive or fraudulent conduct,

and the types of disclosures that are material to business opportunity purchasers.

In addition to soliciting written comments, the Commission staff held three public workshops specifically addressing business opportunity sales issues. These were held in Chicago, Dallas, and Washington, DC. The workshop participants included: Business opportunity promoters; the Direct Sellers Association (“DSA”); several of DSA's multilevel marketer members (

e.g.

, Amway, Longaberger Company, Pampered Chef); several attorneys who represent business opportunity promoters; state regulators; and several franchise and distribution law attorneys.

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 attached as Attachment B.

ANPR, 62 FR at 9116-117 and 9121 (Question 12).

ANPR, 62 FR at 9121 (Questions 8-10).

ANPR, 62 FR at 9121 (Questions 15-16).

4. Franchise Rule Notice of Proposed Rulemaking

After assessing the comments received in response to the ANPR, the Commission decided to amend the Franchise Rule and, to that end, published a Franchise Rule Notice of Proposed Rulemaking (“Franchise Rule NPR”), soliciting comment on proposed revisions to the Franchise Rule.

At the same time, the Commission announced its intention to conduct a separate rulemaking to address business opportunity sales.

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. Without proposing any specific Business Opportunity Rule provisions at that time, the Commission noted that:

Franchise Rule NPR, 64 FR 57294 (October 22, 1999). References to the comments responding to the Franchise Rule NPR are cited as: Name of commenter, FR-NPR, commenter number (

e.g.

, IFA, FR-NPR 22). A list of the FR-NPR commenters and the abbreviations used to identify each is attached as Attachment C.

Franchise Rule NPR, 64 FR at 57296.

[M]any of the [Franchise] Rule's pre-sale disclosures, in particular those pertaining to the parties' detailed relationship, do not apply to the sale of most business opportunities, which typically involve fairly simple contracts or purchase agreements. The Rule's detailed disclosure obligations may also create barriers to entry for legitimate business opportunity sellers.

Franchise Rule NPR, 64 FR at 57296.

Section B. Need for a Separate Business Opportunity Rule

Based upon its enforcement experience and the record developed to date, the Commission has determined to promulgate a separate trade regulation rule to address widespread fraud in the sale of business opportunities. This approach is consistent with the view of the vast majority of commenters and the regulatory approaches adopted in most states.

Rule Review and ANPR commenters and participants overwhelmingly urged the Commission to promulgate a separate business opportunity rule.

As an initial matter, several commenters observed 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.

Also, in contrast to franchises, many business opportunity programs have no continuing relationship between the buyer and seller, but are a one time purchase of packaged information.

E.g.,

Muncie, ANPR 15, at 2; Baer, ANPR 25; H&H, ANPR 28, at 6; Kaufmann, ANPR 33, at 6; DSA, ANPR 34, at 1; IL AG, ANPR 77, at 3; IFA, ANPR 82, at 2; Caffey, ANPR 94, at 1-2; Jeffers, ANPR 116, at 2; NASAA, ANPR 120, at 4; Selden, ANPR 133, at 2; Cendant, ANPR 140; Wieczorek, RR 23, at 2-3; CA BLS, RR 45, at 5-6; Forte Hotels, RR 52, at 2.

See also

Harrington, Sept95 Tr at 285 (noting complete consensus among public workshop participants for a separate business opportunity rule).

But see

NCL, ANPR 35 (“While there may be clear distinctions with those involved in the trade for franchises and business opportunities, the consumers who contact the NFIC are unaware of the differences. Moreover, a review of the NFIC complaints received in 1996 reveals that more involve business opportunities than franchises. This indicates that the same pre-sale disclosures are needed for business opportunities as for franchises.”); Cory, ANPR 12; McBirney, RR 7, at 2; Perry RR 44, at 3 (arguing that the Commission should create a level playing field between all income generating opportunities, subjecting each to the same disclosure approach).

E.g.,

IFA, FR-NPR 22, at 4; NASAA, ANPR 120, at 2-3; DSA, RR 21, at 3-4; Wieczorek, RR 23, at 2-3; D'Imperio, Sept95 Tr at 130; Kezios, Sept95 Tr at 365, 631.

Caffey, ANPR 94, at 2.

Further, unlike most franchises, many business opportunities are permeated with fraud.

Perhaps one business opportunity and franchise consultant said it best when she described many business opportunity sellers as:

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.

Individuals who go from one business opportunity to the next, violating laws, committing frauds, taking funds without delivering what was promised only to shut down the operation within a year and move on to another one with new officers, new company names, and new products.

Chistopher, ANPR 115, at 1.

At the Washington, DC public workshop conference, a business opportunity seller described an informal survey of business opportunity advertisements in the

Boston Globe.

He stated that in February 1997, he observed advertisements for 23 business opportunity ventures. When he attempted to call the advertised numbers the following August, he found “20 of them were disconnected, meaning they shut down, left one to a thousand people with no customer support, no parts for machines, no parts whatsoever.” M. Garceau, 20Nov97 Tr at 28-29.

Other commenters observed that business opportunity sellers take advantage of the Franchise Rule's narrow focus to avoid disclosure obligations.

Other commenters asserted that business opportunity sellers do not comply with the Franchise Rule because compliance costs are too high.

For example, attorney Kat Tidd explained:

Kestenbaum, RR 14, at 3-4 (“Too many companies are trying to avoid the disclosure requirements of the Rule by sidestepping the franchise definition and taking a position that what they do is not defined under the FTC Rule.”).

See also

Caffey, 20Nov97 Tr at 24 (“I think one of the drawbacks of the existing Rule is it is very narrowly defined. Under the existing Rule * * * if the seller is not locating vending machines or providing assistance for locations, the seller is virtually not covered by the Rule.”); Lewis, Sept95 Tr at 283 (observing that the narrow definition of business opportunity enables business opportunity sellers to conclude that they “are not part of it; it's very easy to say I'm not a franchise and I'm not a bis op [sic].”).

CA BLS suggested that business opportunity sellers will go so far as to change their program to avoid falling within the Franchise Rule's definition of a business opportunity, resulting in reduced protection for prospective purchasers:

[I]f the only reason that a seller's program is falling within the definition of the Rule is that it provides personnel who assist the purchaser in securing sites, it may withdraw this service. In some instances, companies have eliminated independent owner programs altogether rather than attempting to comply with the Rule and the “patchwork quilt” of multiple and diverse state regulations.

CA BLS, RR 45, at 6-7.

See also

Muncie, ANPR 15, at 2 (suggesting that Franchise Rule coverage of business opportunities “only serve[s] to drive legitimate companies out of the marketplace, thereby harming consumers.”).

From my experience as a franchise attorney of more than 15 years, many entrepreneurs will choose to risk not complying with the Rule because the cost of compliance is too high relative to the size of the company, the size of the investment to be made and/or the number of, or profits to be derived from, the sale of opportunities.

Tidd, ANPR 112, at 1.

See also

Muncie, ANPR 15, at 3; Baer, ANPR 25, at 5; Tifford, ANPR 78, at 4-5; D'Amico, Sept95 Tr at 151, 154; Huke,

id.

at 240; Simon,

id.

at 281; Lewis,

id.

at 284. A few commenters, however, suggested that disclosures for business opportunity sales should be “stronger” than those for franchise sales.

E.g.,

Cory, ANPR 12; D'Imperio, Sept95 Tr at 132; Perry,

id.

at 258-59.

In the event that a revised Franchise Rule is promulgated before a new Business Opportunity Rule, business opportunities presently covered by the original Franchise Rule could remain covered by that rule pending completion of this rulemaking. For example, the Commission could finalize a revised Franchise Rule (16 CFR part 436), and simultaneously publish a modified version of the original Franchise Rule that would be named the “Business Opportunity Rule” (16 CFR part 437). This rule might differ from the original Franchise Rule in two respects. First, references to “franchisor” and “franchisee” in the original Franchise Rule would be changed to “business opportunity seller” and “business opportunity purchaser,” respectively. Second, the term “franchise” would be deleted from the original Franchise Rule's definitions and would be replaced with “business opportunity.” Further, the first part of the original definition—the “franchise” elements—would be deleted; the revised definition would focus on the second part of the original definition—the business opportunity elements. Except for these changes, all disclosures and prohibitions in part 437 would be identical to those of the original Franchise Rule.

Section C. Overview of the Proposed Rule

In drafting a Business Opportunity Rule, the Commission relies heavily on its law enforcement experience in addressing a wide array of business opportunity fraud under both the Franchise Rule and section 5 of the FTC Act. The Commission also relies on the staff's analysis of consumer complaints submitted to the FTC.

By far, the most frequent allegations in Commission business opportunity cases pertain to false or unsubstantiated earnings claims.

This is followed by false testimonials or fictitious references and misrepresentations concerning the profitability of locations, availability of support and assistance, nature of the products or services sold, prior success of the seller or locator, full extent of investment costs, and refund policies.

These alleged material misrepresentations or omissions also were most frequently mentioned in complaints to the Commission submitted by business opportunity purchasers.

See

Bureau of Consumer Protection Staff,

Franchise and Business Opportunity Program Review 1993-2000: A Review of Complaint Data, Law Enforcement, and Consumer Education

(June 2001) (“Staff Program Review”) (available at

http://www.ftc.gov/reports/franchise93-01.pdf

See also

Tifford, ANPR 78, at 4-5 (“[T]he FTC should draw upon its own experience with business opportunity enforcement in fashioning a definition that would encompass the business opportunity arrangements which have been the source of most of the consumer injury, as well as focusing on the types of disclosures that are best suited for business opportunity purchasers.”).

Staff Program Review,

supra

note 39, Table I.1; I.2. (127 Franchise Rule allegations; 94 Section 5 allegations pertaining to earnings claims issues in FTC enforcement actions).

See also

NCL, ANPR 35, at 2.

Staff Program Review,

supra

note 39, Table I.2.

Id.,

Appendix 5 (listing earnings claims; lack of promised support, locations, or training; exclusive territory and cost misrepresentations; and refund issues among most prevalent business opportunity complaints).

The proposed Rule would address these practices by requiring five affirmative disclosures.

The first

affirmative disclosure would require a business opportunity seller to state whether the seller chooses to make earnings claims. If the seller does, then the proposed Rule would require substantiation and additional disclosures. The other four affirmative disclosures pertain to certain prior litigation; the seller's cancellation or refund policies; statistics on cancellation and refund requests; and contact information for prior purchasers as references.

Consistent with the Franchise Rule, the Commission does not express any opinion about the legality of any practices that might be disclosed under the proposed Rule.

See

16 CFR part 436, note 1. In the Franchise Rule SBP, the Commission

recognized that the Franchise Rule may require franchisors to disclose practices that may raise antitrust issues. SBP, 43 FR at 59719. While antitrust issues are probably less of a concern in the narrowly tailored Business Opportunity Rule context, the Commission nevertheless reserves the right to pursue violations of antitrust laws even if a business opportunity seller discloses a violation in complying with the proposed Rule's disclosure requirements. In short, disclosure does not create a safe harbor for engaging in otherwise unlawful conduct.

Further, a business opportunity seller may have an obligation under section 5 of the FTC Act to impart material information to prospective purchasers beyond the disclosures required by this proposed Rule. This clarification is critical, especially in an age of quickly developing changes in the marketplace. The Commission cannot now predict what types of business opportunities will be offered in the future, nor the information a business opportunity purchaser will find material. This does not mean that a seller must include additional information in its disclosure document. As noted below, proposed section 437.5(c) prohibits the inclusion of additional information in a disclosure document. Rather, when a seller must impart material information beyond that required by the Rule, it must provide the information separately from its disclosure document. The Commission does not purport to specify how such information must be disseminated, permitting sellers the flexibility to decide which method is best for their particular business.

In addition to these disclosure requirements, the proposed Rule would prohibit common deceptive business opportunity sales practices. Among other things, business opportunity sellers would be prohibited from misrepresenting: (1) Earnings; (2) costs or the efficacy, nature, or central characteristics of the business opportunity or the goods or services sold to the purchaser as part of the business opportunity; (3) cancellation or refund policies; (4) promised assistance; (5) the calculation and distribution of commissions, bonuses, incentives, premiums, or other payments from the seller; (6) the likelihood of finding locations for equipment or accounts for services; (7) a business opportunity as an offer of employment; (8) territorial exclusivity or more limited territorial protections; (9) endorsements; and (10) shills as references. Finally, the proposed Rule would prohibit business opportunity sellers from failing to make promised refunds, as well as assigning “to any purchaser a purported exclusive territory that, in fact, encompasses the same or overlapping areas already assigned to another purchaser.”

Section D. Scope of the Proposed Rule

1. Business Opportunities Covered by the Franchise Rule

The proposed Rule would continue to cover those business opportunities that are presently covered by the original Franchise Rule. The Commission's law enforcement experience demonstrates that sales of these opportunities are fraught with unfair and deceptive practices, in particular the making of false or unsubstantiated earnings claims.

Indeed, such practices are widespread. Since 1990 alone, the Commission has brought more than 140 Franchise Rule cases against vending machine, rack display, and similar opportunities. Since 1995, the Commission has conducted more than 11 business opportunity sweeps,

many with other federal and state law enforcement partners, to combat persistent business opportunity scams violating the Franchise Rule, such as those involving the sale of vending machines,

rack displays,

public telephones,

Internet kiosks,

and 900-number ventures,

among others.

E.g.,

Project Telesweep (1995); Operation Missed Fortune (1996); Project Trade Name Games (1997); Project Vend Up Broke (1998); Project Bizillion$ (1999); Project Busted Opportunity (2002); and Project Biz Opp Flop (2005). In addition to joint law enforcement sweeps, Commission staff has also targeted specific business opportunity ventures such as 900 numbers (Project Buylines 1996); vending (Project Yankee Trader 1997); seminars (Operation Showtime 1998); medical billing (Project House Call 1998); and Internet-related services (Net Opportunities 1998).

See, e.g., FTC

Am. Entm't Distribs., Inc.,

No. 04-22431-CIV-Huck (2004);

FTC

Pathway Merch., Inc.,

No. 01-CIV-8987 (S.D.N.Y. 2001);

U.S.

Photo Vend Int'l, Inc.,

No. 98-6935-CIV-Ferguson (S.D. Fla. 1998);

FTC

Hi Tech Mint Sys., Inc.,

No. 98 CIV 5881 (JES) (S.D.N.Y. 1998);

FTC

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).

See, e.g., U.S.

Elite Designs, Inc.,

No. CA 05 058 (D.R.I. 2005);

U.S.

QX Int'l,

No. 398-CV-0453-D (N.D. Tex. 1998);

FTC

Carousel of Toys,

No. 97-8587-CIV-Ungaro-Benages (S.D. Fla. 1997);

FTC

Raymond Urso,

No. 97-2680-CIV-Ungaro-Benages (S.D. Fla. 1997);

FTC

Infinity Multimedia, Inc.,

No. 96-6671-CIV-Gonzalez (S.D. Fla. 1996);

FTC

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).

See, e.g., FTC

Advanced Pub. Commc'ns Corp.,

No. 00-00515-CIV-Ungaro-Benages (S.D. Fla. 2000);

FTC

Ameritel Payphone Distribs., Inc.,

No. 00-0514-CIV-Gold (S.D. Fla. 2000);

FTC

ComTel Commc'ns Global Network, Inc.,

No. 96-3134-CIV-Highsmith (S.D. Fla. 1996);

FTC

Intellipay, Inc.,

No. H92 2325 (S.D. Tex. 1992).

See, e.g., FTC

Bikini Vending Corp.,

No. CV-S-05-0439-LDG-RJJ (D. Nev. 2005);

FTC

Network Service Depot, Inc.,

No. CV-S0-05-0440-LDG-LRL (D. Nev. 2005);

U.S.

Am. Merch. Tech.,

No. 05-20443-CIV-Huck (S.D. Fla. 2005);

FTC

Hart Mktg. Enter. Ltd., Inc.,

No. 98-222-CIV-T-23 E (M.D. Fla. 1998).

See also FTC

FutureNet, Inc.,

No. CV-98-1113 GHK (BQRx) (C.D. Cal. 1998);

FTC

TouchNet, Inc.,

No. C98-0176 (W.D. Wash. 1998).

See, e.g., FTC

Bureau 2000 Int'l, Inc.,

No. 96-1473-DT-(JR) (C. D. Cal. 1996);

FTC

Genesis One Corp.,

No. CV-96-1516-MRP (MCX) (C. D. Cal. 1996);

FTC

Innovative Telemedia, Inc.,

No. 96-8140-CIV-Ferguson (S. D. Fla. 1996);

FTC

Ad-Com Int'l,

No. 96-1472 LGB (VAP) (C.D. Cal. 1996).

Further, business opportunity ventures covered by the Franchise Rule continue to stand out as a major source of consumer complaints.

In fact, business opportunities covered by the Franchise Rule consistently rank among the top 10 categories of consumer fraud complaints reported to the Commission.

See

FTC,

The FTC in 2005: Standing Up For Consumers and Competition

(2005) (available at

http://www.ftc.gov/os/2005/04/0504abareportfinal.pdf

), at 18 (announcing 14 criminal indictments in connection with business opportunity fraud); FTC Staff Report,

Consumer Fraud in the United States: An FTC Survey

(Aug. 2004) (“Fraud Survey”) (available at

http://www.ftc.gov/reports/consumerfraud/040805confraudrpt.pdf

) at 48 (showing 450,000 victims of business opportunity fraud).

See, e.g.

, FTC News Release: Criminal and Civil Enforcement Agencies Launch Major Assault Against Promoters of Business Opportunity and Work-at-Home Schemes (Feb. 22, 2005) (available at

http://www.ftc.gov/opa/2005/02/bizoppflop.htm

) (defendants in FTC cases alone caused tens of thousands of consumers to lose a total of more than $100 million); FTC News Release: Law Enforcers Target “Top 10” Online Scams; Consumer Protection Cops From 9 Countries, 5 U.S. Agencies, and 23 States Tackle Internet Fraud (Oct. 31, 2000) (available at

http://www.ftc.gov/opa/2000/10/topten.htm

) (listing business opportunities and work-at-home schemes among the top 10 Internet frauds).

See also

Prepared Statement of Federal Trade Commission on “Internet Fraud” before the House Subcomm. on Commerce, Trade, and Consumer Protection of the Comm. on Energy and Commerce (May 23, 2001) (available at

http://www.ftc.gov/opa/2001/05/iftestimony.htm

) (listing pyramids, business opportunities, and work-at-home schemes among the top Internet frauds); Prepared Statement of the Federal Trade Commission on “Internet Fraud” before the Senate Comm. on Finance (April 5, 2001) (available at

http://www.ftc.gov/os/2001/04/internetfraudstate.htm

) (listing pyramid, business opportunities, and work-at-home schemes among the top 10 Internet frauds based on Consumer Sentinel Database).

Moreover, such scams typically cost consumers thousands of dollars.

While precise figures of consumer injury from fraudulent business opportunity ventures is unknown, the Commission's law enforcement experience reveals that it is not uncommon for purchasers of fraudulent business opportunities to lose thousands of dollars each.

For these reasons, the Commission has determined that sales of vending machines, rack displays, and similar opportunities should be covered by the Business Opportunity Rule, now that the Franchise Rule is being amended to focus exclusively on the sale of franchises.

2. Business Opportunities Not Presently Covered by the Franchise Rule

The proposed Business Opportunity Rule would also address the sale of other business arrangements that are currently outside the scope of the Franchise Rule, but have been shown by the Commission's law enforcement experience and complaint data to be sources of prevalent and persistent problems. Two important types of fraudulent or deceptive opportunities that would fall within the proposed Rule's coverage are work-at-home schemes and pyramid marketing schemes.

E.g., FTC

World Traders Ass'n, Inc.,

No. CV05 0591 AHM (CTx) (C.D. Cal. 2005) (estimated $30 million in consumer injury);

FTC

Am. Entm't

Distribs.,

No. 04-22431-CIV-Huck (S.D. Fla. 2004) (estimated $20 million in consumer injury).

See also

United States Postal Inspection Service, News Release: U.S. Postal Inspectors, Federal Trade Commission, Department of Justice dismantle business-opportunity scams (“Postal Inspectors have arrested 28 individuals * * * who victimized more than 140,000 consumers with estimated losses exceeding $73 million.”).

E.g., FTC

Am. Entm't Distribs.,

No. 04-22431-CIV-Huck (S.D. Fla. 2004) ($28,000-$37,500 for one machine);

FTC

Accent Mktg., Inc.,

No. 02-0405-CB-M (S.D. Ala. 2002) ($8,000 initial payment). One measure of injury attributed to business opportunity fraud can be gleaned from the 2001 Staff Program Review. In its review of 2,665 business opportunity complaints from 1997 through the first half of 1999, over 70% of complainants reported losses of at least $1,000, with over 48% reporting losses of over $5,000. Approximately 24% reported losses over $10,000. Staff Program Review,

supra

note 39, at 36.

In response to the ANPR, state regulators argued for a broad rule covering a wide array of opportunities. For example, in its ANPR Comment, NASAA recommended that the disclosure requirements for business opportunity ventures include business opportunity formats such as multilevel marketing plans, seller-assisted marketing plans, work-at-home plans and certain distributorships and licensing plans not currently covered under the Franchise Rule. NASAA, ANPR 120, at 5.

See also

James, ANPR 76; WA Securities, ANPR 117, at 2; Maxey, Sept95 Tr at 38.

a. Work-at-Home Schemes

Deceptive work-at-home schemes are a persistent type of fraud, preying upon stay-at-home parents, the physically disabled, non-English speakers, and others who cannot obtain employment outside of the home.

For the most part, they are not distinguishable in any material respect from business opportunities covered by the existing Franchise Rule.

See, e.g., FTC

USS A Enter., Inc.,

No. SA CV-04-1039 AHS (ANx) (C.D. Cal. 2004) (craft assembly opportunity aimed at Spanish speakers);

FTC

Esteban Barrios Vega,

No. H-04-1478 (S.D. Tex. 2004) (product assembly opportunity aimed at Spanish speakers);

FTC

Castle Publ'g, Inc.,

No. AO3CA 905 SS (W.D. Tex. 2003) (envelope-stuffing opportunity targeting unemployed, disabled, and elderly hoping to work from home);

FTC

Medicor LLC,

No. CV01-1896 (CBM) (C.D. Cal. 2001) (work-at-home scams victimizing stay-at-home parents, the physically disabled, and non-English speakers).

See also

James, 21Nov97 Tr at 344 (describing work-at-home program aimed at the elderly and poorly-educated).

See

discussion above in Section A.1 explaining that the Franchise Rule's limitation requiring purchasers to sell directly to end-users effectively exempts many work-at-home opportunities from Franchise Rule coverage.

Sellers of fraudulent work-at-home opportunities deceive their victims with promises of an ongoing relationship in which the seller will buy the output that opportunity purchasers produce. These sellers often misrepresent that there is a market for a purchaser's goods and services,

just as sellers of fraudulent vending machine and rack display opportunities falsely claim that profitable vending locations are available.

Work-at-home opportunity sellers also often claim to provide ongoing training and other assistance, as business opportunity sellers covered by the Franchise Rule often do.

Each of these promises by work-at-home opportunity sellers is often just as illusory as the analogous promises made by business opportunity sellers covered by the Franchise Rule. In addition, fraudulent work-at-home opportunity sellers frequently invent undisclosed conditions and limitations for rejecting the work performed by purchasers and refusing to buy back the goods the purchasers produce.

Similarly, these sellers' promises of continuing support and assistance frequently prove empty, leaving work-at-home opportunity purchasers with no help in figuring out how to assemble misshapen components into finished products.

E.g., FTC

Misty Stafford,

No. 3: CV 05-0215 (M.D. Pa. 2005);

FTC

Elec. Med. Billing, Inc.,

No. SA02-368 AHS (ANX) (C.D. Cal. 2003);

FTC

Holiday Magic,

No. C 93-4038 VRW (N.D. Cal. 1994);

In re New Mexico Custom Designs, Inc.,

FTC C-3485 (1993);

In re Sandcastle Creations,

FTC C-3484 (1993);

In re Homespun Prods., Inc.,

FTC C-3483 (1993);

In re Hairbow Co.,

FTC C-3482 (1993).

See

James, 21Nov97 Tr at 343 (bead assembly seller falsely represented a relationship with J.C. Penney).

E.g., FTC

Nat'l Vending Consultants, Inc.,

No. CV-S-05-0160-RCJ-PAL (D. Nev. 2005);

FTC

Pathway Merchandising, Inc.,

No. 01-CIV-8987 (S.D.N.Y. 2001);

FTC

Int'l Computer Concepts, Inc.,

No. 1:94CV1678 (N.D. Ohio 1994).

E.g., FTC

USS Elder Enter., Inc.,

No. SA CV-04-1039 AHS (ANx) (C.D. Cal. 2004) (company would provide work or substantial assistance in obtaining work);

FTC

Leading Edge Processing, Inc.,

No. 6:02-CV-681-ORL-19 DAB (M.D. Fla. 2003) (company would provide specialized software, manuals, and training);

FTC

Fin. Res. Unlimited,

No. 03-C-8864 (N.D. Ill. 2003) (no prior experience necessary; company would provide all supplies needed);

FTC

Darrell Richmond,

No. 3:02-3972-22 (D.S.C. 2003) (seller claimed to provide all necessary materials to perform the work-at-home envelope stuffing business);

FTC

Elec. Med. Billing, Inc.,

No. SACV02-368 AHS (ANX) (C.D. Cal. 2003) (company promised to provide everything necessary to perform medical billing, including a list of doctors, training, and software).

See also

Finnigan, 21Aug97 Tr at 95 (a business or income-earnings opportunity inherently must offer some sort of assistance or training); Catalano, 20Nov97 Tr at 37 (purchasers buy business opportunities to obtain the seller's expertise and know-how).

See FTC

Misty Stafford,

No. 3: CV 05-0215 (M.D. Pa. 2005).

See also

James, 21Nov97 Tr at 244-45 (describing clown assembly work-at-home program that repeatedly rejected goods produced by investor).

Moreover, as the Commission's cases and complaint data demonstrate, the con artists who promote fraudulent work-at-home schemes frequently dupe consumers with false earnings claims,

a very prevalent practice among fraudulent business opportunity sellers. For example, in one envelope-stuffing case brought under section 5 of the FTC Act, the defendant allegedly offered to pay purchasers $550 to $3,000 weekly.

Similarly, in a medical billing work-at-home case, the defendant allegedly promised purchasers annual incomes of $25,000-$50,000.

Because the initial investment is relatively low, hundreds of thousands of bilked consumers do not formally complain or take action against these illegal operators.

E.g., FTC

Sun Ray Trading,

No. 05-20402 CIV-Sitz/Bandstra (S.D. Fla. 2005) (potential weekly income of $550 to $3,000);

FTC

Castle Publ'g, Inc.,

No. AO3CA 905 SS (W.D. Tex. 2003) (earn $2,900 to $5,000 and more weekly);

FTC

Darrell Richmond,

No. 3:02-3972-22 (D.S.C. 2002) (earn between $100 and $1,000 or more per week).

See also

James, 21Nov97 Tr at 341 (describing a bead assembly work-at-home program that claimed earnings of $1,400 per $1,000 investment).

FTC

Fin. Res. Unlimited,

No. 03-C-8864 (N.D. Ill. 2003) (earn “$550.00 to $3,000 and more weekly” stuffing envelopes).

FTC

Elec. Med. Billing, Inc.,

No. SA02-368 AHS (AN) (C.D. Cal. 2002).

The Commission's law enforcement experience demonstrates that work-at-home scams are widespread, causing significant consumer injury. Indeed, since 1990 the Commission has brought over 60 work-at-home cases.

These actions have targeted a variety of schemes, ranging from envelope

stuffing

and craft assembly programs,

to technology-driven opportunities,

including medical billing plans.

In some of these cases, what appeared to be simple work-at-home scams turned out to be illegal pyramid schemes.

Consumer complaints to the Commission also demonstrate the prevalence of fraudulent work-at-home schemes.

To determine the level of complaints and alleged injury from work-at-home scams, the Commission staff analyzed fraud complaint information from the Commission's complaint database for the period January 1997 through December 2005. The staff's analysis shows 37,333 work-at-home complaints, resulting in alleged injury of over $15 million ($15,408,934).

Indeed, work-at-home complaints ranked among the top fraud complaint categories submitted to the Commission. For example, during the period studied, work-at-home schemes ranked among the top 20 fraud complaint categories each year:

Many of these cases were brought in connection with sweeps of fraudulent work-at-home and related employment opportunities, including Project Biz Opp Flop (2005); Project Homework (2001); Operation Top Ten Dot Con (2000); and Operation Missed Fortune (1996).

E.g., FTC

Sun Ray Trading,

No. 05-20402 CIV-Seitz/Bandstra (S.D. Fla, 2005);

FTC

Fin. Res. Unlimited,

No. 03-C-8864 (N.D. Ill. 2003);

FTC

Castle Publ'g, Inc.,

No. AO3CA 905 SS (W.D. Tex. 2003);

FTC

Patrick Cella,

No. CV03-3202 GAF (SHSx) (W.D. Cal. 2003);

FTC

Terrance Maurice Howard,

No. SA02CA0344 (W.D. Tex. 2002);

FTC

Stuffingforcash.com, Corp.,

No. 92 C 5022 (N.D. Ill. 2002);

FTC

America's Shopping Network, Inc.,

No. 02-80540-CIV-Hurley (S.D. Fla. 2002).

E.g., FTC

Misty Stafford,

No. 3: CV 05-0215 (M.D. Pa. 2005);

FTC

Esteban Barrios Vega,

No. H-04-1478 (S.D. Tex. 2004);

FTC

Nat'l Crafters, Corp.,

No. 01-4825-CIV-Graham-Turnoff (S.D. Fla. 2001);

FTC

Ed Boehlke,

No. 96-0482-E-BLW (D. Idaho 1996);

In re Sandcastle Creations,

FTC C-3484 (1993);

In re Hairbow Co.,

FTC C-3482 (1993);

FTC

Holiday Magic,

No. C 93-4038 VRW (N.D. Cal. 1993);

In re Homespun Prods., Inc.,

FTC C-3483 (1993);

In re New Mexico Custom Designs, Inc.,

FTC C-3485 (1993).

See also

Prepared Statement of the FTC on “Internet Fraud” before the House Subcomm. on Commerce, Trade, and Consumer Protection, Comm. on Energy and Commerce (May 23, 2001) (listing business opportunities and work-at-home schemes among top 10 Internet or online scams); Prepared Statement of the FTC on “Internet Fraud” before the Senate Comm. on Finance (April 5, 2001) (listing business opportunities and work-at-home schemes among top 10 online scams).

E.g., FTC

Wealth Sys., Inc.,

No. CV 05 0394 PHX JAT (D. Ariz. 2005) (web design);

FTC.

Leading Edge Processing, Inc.,

No. 6:02-CV-681-ORL-19 DAB, (M.D. Fla. 2002) (data entry);

FTC

LS Enter.,

FTC C-3884 (1999) (bulk email);

In re Computer Bus. Servs.,

FTC C-3705 (1996) (in-home computer work);

FTC

AMP Publ'n, Inc.,

No. SACV-00-112-AHS-ANx (C.D. Cal. 2000) (in-home computer work).

E.g., FTC

Med. Billers Network, Inc.,

No. 05 CV 2014 (RJH) (S.D.N.Y. 2005);

FTC

Elec. Med. Billing,

No. SA02-368 AHS (AN) (C.D. Cal. 2002);

FTC

Elec. Processing Servs., Inc.,

No. CV-S-02-0500-L.H.-R.S. (D. Nev. 2002);

FTC

Medicor, LLC,

No. CV01-1896 (CBM) (C.D. Cal. 2001);

FTC

Encore Networking Servs.,

No. 00-1083 WJR (AIJx) (C.D. Cal. 2000);

FTC

Physicians Healthcare Dev. Serv. Corp.,

No. CV-02-2936 RMT (C.D. Cal. 2000);

FTC

Data Med. Capital, Inc.,

No. SACV-99-1266 AHS (C.D. Cal. 1999);

FTC

Elec. Filing Acad.,

No. 98-0054-PHX-EHC (D. Ariz. 1998).

E.g., FTC

David Martinelli, Jr.,

No. 3:99 CV 1272 (CFD) (D. Conn. 1999) (income from work-at-home opportunity processing applications dependent upon signing new recruits to join the opportunity).

In adopting amendments to the Telemarketing Sales Rule (“TSR”), the Commission observed “that telemarketing fraud perpetuated by the advertising of work-at-home and other business opportunity schemes in general media sources is a prevalent and growing phenomenon.” Indeed, the Commission stated that “the single greatest per capita monetary loss category in complaints reported to the FTC is for business opportunities, including work-at-home schemes.” 67 FR 4492, at 4530 (Jan. 30, 2002).

See also

TSR Statement of Basis and Purpose, 68 FR 4480, at 4661 (Jan. 29, 2003).

ee also

James, 21Nov97 Tr at 340-45 (describing three work-at-home opportunities in Florida, one of which took in $18 million, victimizing 6,000 consumers).

Year

Rank

Complaints

1997

5th

1,399

1998

20th

1,653

1999

19th

2,611

2000

18th

3,448

2001

13th

4,852

2002

11th

17,307

2003

9th

16,694

2004

12th

6,485

2005

15th

4,366

Were it not for the minimum investment requirement and direct sales to end-user limitation in the Franchise Rule, many work-at-home schemes would be covered by that rule because the same potential for abuse exists as with vending machines and rack display opportunities, which are covered. In view of the misrepresentations and omissions that fraudulent work-at-home opportunity sellers have used, as shown by consumer complaints and past Commission cases, the Commission has determined that the proposed business opportunity disclosure requirements and prohibitions would provide potential work-at-home purchasers with the tools they need to protect themselves from false claims.

b. Pyramid Marketing Schemes

Like business opportunities covered by the existing Franchise Rule, pyramid schemes often deceive consumers with the promise of large potential incomes. It is not uncommon for promoters of these schemes to claim potential incomes of thousands of dollars a week or month.

Because of the claimed high earnings potential, pyramid schemes are highly successful in attracting prospective investors. For example, one pyramid program attracted more than 150,000 consumers who collectively paid over $80 million during the course of three years.

Indeed, cases brought under section 5 against pyramid marketing promotions have resulted in huge consumer redress, such as $40 million in

Equinox

and $20 million in

SkyBiz.com.

E.g., FTC

2Xtreme Performance Int'l, LLC,

No. JFM 99CV 3679 (D. Md. 1999) (“about $2,000 in the first month * * * and then it went to $60,000”);

FTC

Bigsmart.com,

No. CIV 01-0466 PHX ROS (D. Ariz. 2001) (“50 people made over $50,000 their first month! We also had a $100,000 first month money earner!”);

FTC

FutureNet, Inc.,

No. CV-98-1113 GHK (BQRx) (C.D. Cal. 1998) (“If you're serious, we can show you how to make ten thousand a month * * * And, you know, we have people doing thirty thousand a month.”);

FTC

Nia Cano,

No. 97-7947-CAS (AJWx) (C.D. Cal. 1997) (as much as $18,000 per month);

FTC

Global Assistance Network for Charities,

No. 96-2494 PHX RCB (D. Ariz. 1996) (promising over $89,000 a month);

FTC

NexGen3000.com,

No. CIV-03-120 TUC WDB (D. Ariz. 2003) (“each activated business center has the potential to earn up to $60,000 per week”);

FTC

SkyBiz.com,

No. 01-CV-0396-EA (X) (N.D. Okla. 2001) (“he's making 76,000 a week and growing”).

FTC

2Xtreme Performance Int'l, LLC,

No. JFM 99CV 3679 (D. Md. 1999).

See also FTC

Fortuna Alliance, LLC,

No. C96-799M (W.D. Wash. 1996) (tens of thousands of consumers in over 60 countries);

FTC

Jewelway, Int'l,

No. CV-97 TUC JMR (D. Ariz. 1997) (200,000 investors).

See also FTC

Bigsmart.com,

No. CIV 01-0466 PHX ROS (D. Ariz. 2001) ($5 million for redress);

FTC

Nia Cano,

No. 97-7947-CAS (AJWx) (C.D. Cal. 1997) (nearly $2 million for redress);

FTC

Fortuna Alliance, LLC,

No. C96-799M (W.D. Wash. 1996) (approximately $5.5 million for redress);

FTC

FutureNet, Inc.,

No. CV-98-1113 GHK (BQRx) (C.D. Cal. 1998) ($1 million for redress);

FTC

Jewelway, Int'l,

No. CV-97 TUC JMR (D. Ariz. 1997) ($5 million for redress);

FTC

ICR Servs.,

No. 03 C 5532 (N.D. Ill. 2003) ($1.5 million for redress).

The prevalence of false earnings claims is not the only similarity between pyramid schemes and business opportunity frauds covered by the current Franchise Rule. Many induce new recruits with the promise of an ongoing commercial relationship that will enable recruits to operate their own business selling various products or services.

Typically, they promise to provide recruits with promotional assistance.

Some also offer training.

Few, however, reveal their high drop-out rates, much less the fact that the vast majority of those who have joined the program—often 90 percent or more—will not recoup their investment.

E.g., FTC

Trek Alliance, Inc.,

No. 02-9270 SJL (AJWx) (C.D. Cal. 2002);

FTC

Equinox, Int'l,

No. CV-S-99-0960-JBR-RLH (D. Nev. 1999);

FTC

FutureNet, Inc.,

No. CV-98-1113 GHK (BQRx) (C.D. Cal. 1998).

E.g., FTC

2Xtreme Performance Int'l, LLC,

No. JFM 99CV 3679 (D. Md. 1999);

FTC

Bigsmart.com,

No. CIV 01-0455 PHX ROS (D. Ariz. 2001);

FTC

NexGen3000.com,

No. CIV-03-120 TUC WDB (D. Ariz. 2003).

FTC

World Class Network, Inc.,

No. SACV-97-162-AHS (EEx) (C.D. Cal. 1997).

Peter J. VanderNat and William W. Keep,

Marketing Fraud: An Approach to Differentiating Multilevel Marketing from Pyramid Schemes

, 21 J. of Pub. Pol'y & Marketing (Spring 2002), at 139-151.

Further, since 1990, the Commission has brought 20 cases against pyramid

schemes under section 5.

These matters have involved a wide range of purported product sales or investments, ranging from the mundane

(nutritional supplements, beauty aids, weight-loss products, and water filters) to the unusual (auto leasing,

charitable giving,

unsecured credit cards,

credit repair,

travel agency credentials,

Internet malls,

and Internet access

). Indeed, pyramid fraud has gone high-tech, flooding the Internet

and consumers' email boxes.

E.g., FTC

Trek Alliance, Inc.,

No. 02-9270 SJL (AJWx) (C.D. Cal. 2002);

FTC

Streamline Int'l,

No. 01-6885-CIV-Ferguson (S.D. Fla. 2001);

FTC

Bigsmart.com,

No. CIV 01-0466 PHX ROS (D. Ariz. 2001);

FTC

Five Star Auto Club, Inc.,

No. CIV-99-1693 McMahon (S.D.N.Y. 1999); FTC v.

2Xtreme Performance Int'l, LLC,

No. JFM 99CV 3679 (D. Md. 1999);

FTC

Equinox, Int'l,

No. CV-S-99-0969-JBR-RLH (D. Nev. 1999);

FTC

FutureNet, Inc.,

No. CV-98-1113 GHK (BQRx) (C.D. Cal. 1998).

E.g., FTC

Trek Alliance, Inc.,

No. 02-9270 SJL (AJWx) (C.D. Cal. 2002);

FTC

Streamline Int'l, Inc.,

No. 01-6885-CIV-Ferguson (S.D. Fla. 2001);

FTC

2Xtreme Performance Int'l,

No. JFM 99CV 3679 (D. Md. 1999);

FTC

Equinox, Int'l,

No. CV-S-99-0969-JBR-RLH (D. Nev. 1999).

FTC

Five Star Auto Club, Inc.,

No. CIV-99-1693 McMahon (S.D.N.Y. 1999).

FTC

Universal Direct,

No. C 3-02-145 (S.D. Ohio 2002);

FTC

Global Assistance Network for Charities,

No. 96-2494 PHX RCB (D. Ariz. 1996).

FTC

Nia Cano,

No. 97-7947-CAS (AJWx) (C.D. Cal. 1997).

FTC

ICR Servs.,

No. 03 C 5532 (N.D. Ill. 2003).

FTC

World Class Network, Inc.,

No. SACV-97-162-AHS (Eex) (C.D. Cal. 1997).

E.g.,

FTC

NexGen3000.com,

No. CIV-03-120 TUC WDB (D. Ariz. 2003);

FTC

Bigsmart.com,

No. CIV 01-0466 PHX ROS (D. Ariz. 2001).

FTC

FutureNet, Inc.,

No. CV-98-1113 GHK (BQRx) (C.D. Cal. 1998).

E.g., FTC

Sun Ray Trading, Inc.,

No. 05-20402-CIV-Seitz/Bandstra (S.D. Fla. 2005);

FTC

2Xtreme Performance Int'l, LLC,

No. JFM 99CV 3679 (D. Md. 1999);

FTC

Nia Cano,

No. 97-7947-CAS (AJWx) (C.D. Cal. 1997);

FTC

FutureNet, Inc.,

No. CV-98-1113 GHK (BQRx) (C.D. Cal. 1998).

E.g., FTC

David Martinelli, Jr.,

No. 3:99 CV 1272 (CFD) (D. Conn. 1999);

FTC

Universal Direct,

No. C 3-02-145 (S.D. Ohio 2002);

In re Kalvin P. Schmidt,

FTC C-3834 (1998).

The Commission staff's analysis of consumer fraud complaint data also demonstrates the prevalence of deceptive pyramid marketing schemes.

For the period January 1997 through December 2005, Commission staff found that consumers lodged 17,858 complaints against pyramid schemes, reporting alleged aggregate injury level of over $46 million ($46,824,347). Indeed, complaints against pyramid marketing companies consistently ranked among the top 20 injury categories reported in consumer fraud complaints to the Commission.

For example, during the period 1997 through 2005, pyramid marketing schemes ranked among the top 20 injury levels each year, except in 2003, as follows:

State regulators report similar data. For example, a Florida business opportunity regulator noted that in his office, 60% of the written complaints received pertain to pyramid marketing companies. “They last about six months and they're gone.” James, 20Nov97 Tr at 115-26. The State of Washington also reported a large number of pyramid marketing scheme complaints. See WA Securities, ANPR 117 at 2.

See also

Fraud Survey,

supra

note 50, at 48 (1.55 million victims of pyramid fraud).

Year

Rank

Injury

1997

9th

$352,769

1998

5th

1,858,787

1999

10th

2,011,012

2000

4th

12,632,132

2001

10th

10,685,083

2002

18th

9,685,722

2003

(not in top 20)

2004

18th

2,264,112

2005

17th

3,347,443

Were it not for the minimum investment and inventory exemptions in the Franchise Rule, many pyramid schemes would be covered because the same potential for abuse exists as with vending machines and rack display opportunities covered by the Franchise Rule.

In view of the misrepresentations and omissions that fraudulent pyramid scheme promoters have used, as shown by consumer complaints and past Commission cases, pre-sale disclosures and prohibitions are necessary to protect potential recruits from deceptive practices.

See

discussion above in Section A.1 explaining that the current Rule's minimum required payment and inventory exemptions effectively exempt many pyramid marketing opportunities from Franchise Rule coverage.

Section E. The Proposed Rule

The proposed Rule is divided into nine sections. Section 437.1 would set forth the Rule's definitions. Section 437.2 would establish the business opportunity seller's obligation to furnish prospective purchasers with material information in the form of a written basic disclosure document. Section 437.3 would specify the content of the basic disclosure document. Section 437.4 would set forth the requirements business opportunity sellers must follow if they elect to make earnings representations. Section 437.5 would prohibit a number of deceptive claims and practices in connection with business opportunity sales. Section 437.6 would set forth the Rule's recordkeeping provisions. Section 437.7 would expressly exempt from the Business Opportunity Rule those business arrangements that are covered by the Franchise Rule. Finally, two administrative sections—437.8 and 437.9—would address other laws, rules, and orders, and severability.

1. Proposed Section 437.1: Definitions

The proposed Rule would begin with a definitions section setting forth defined terms in alphabetical order. In several instances, the proposed definitions closely track those contained in the current Franchise Rule, Commission interpretations of the Franchise Rule, and the states' comparable franchise disclosure document, the Uniform Franchise Offering Circular (“UFOC”) Guidelines. These include the definitions for the terms “action,” “affiliate,” “disclose or state,” “earnings claims,” “person,” and “written.” The Commission also proposes to define the terms “business assistance,” “business opportunity,” “cancellation or refund request,” “designated person,” “exclusive territory,” “general media,” “new business,” “prior business,” “providing locations, outlets, accounts, or customers,” “purchaser,” “quarterly,” and “seller.” Each proposed definition is set forth below.

a. Proposed Section 437.1(a): “Action”

The term “action” arises in proposed section 437.3(a)(3), which would require business opportunity sellers to disclose material information about the seller's prior litigation. Proposed section 437.1(a) would define the term “action” closely tracking the Commission's current interpretation of the term “action” in connection with the Franchise Rule. Specifically, it would make clear that disclosures involving litigation include not only civil actions brought before a court, but matters before arbitrators.

It would also make clear that an “action” includes all governmental actions, including criminal matters, and administrative law enforcement actions, including cease and desist orders, or assurances of voluntary compliance.

See

Interpretive Guides, 44 FR at 49973; Rabenberg, Sept. 95 Tr. at 105, 279 (arguing for the disclosure of matters in arbitration, which normally are not public documents).

See also

Franchise Rule NPR, 64 FR at 57297 and 57332; UFOC Guidelines, Item 3.

b. Proposed Section 437.1(b): “Affiliate”

To combat business opportunity sales fraud, proposed section 437.3(a)(3) would require a business opportunity seller to disclose not only litigation in which it was named as a party, but any litigation naming any of its affiliates. Closely tracking the UFOC Guidelines, proposed section 437.1(b) would define the term “affiliate” to mean: “an entity controlled by, controlling, or under

common control with a business opportunity seller.”

This definition would also cover litigation involving a parent and subsidiaries of the business opportunity seller.

See

NASAA Commentary on the Uniform Franchise Offering Circular Guidelines (1999), Bus. Franchise Guide (CCH), ¶5790, at 8,466. This is a greatly streamlined version of the definition of “affiliated person” in the current Franchise Rule:

The term affiliated person means a person * * * (1) Which directly or indirectly controls, is controlled by, or is under common control with, a franchisor; or (2) Which directly or indirectly owns, controls, or holds with power to vote, 10 percent or more of the outstanding voting securities of a franchisor; or (3) Which has, in common with a franchisor, one or more partners, officers, directors, trustees, branch managers, or other persons occupying similar status or performing similar functions.

16 CFR at 436.2(i).

c. Proposed Section 437.1(c): “Business assistance”

One of the definitional elements of the term “business opportunity” in section 437.1(d) is the offer of “business assistance.” Proposed section 437.1(c) would define “business assistance” to mean “ the offer of material advice, information, or support to a prospective purchaser in connection with the establishment or operation of a new business.”

By using the concept of business assistance as one of the definitional elements of the term “business opportunity”—the term that establishes the parameters of the Rule's coverage—the Commission intends to ensure coverage of those business relationships that involve more than the ordinary sale of goods or services to existing businesses.

As discussed below, the term “new business” also includes a new line of business.

In addition, the proposed definition of “business assistance” lists five illustrative, but not exhaustive, examples of qualifying assistance, corresponding to practices shown by the Commission's law enforcement experience, and that of the states, to be common among sellers of fraudulent business opportunities.

The common thread linking each of these five examples is that the seller promotes his or her expertise in operating the business or in providing a market for the goods or services the purchaser sells to the public, or in ensuring compensation promised to the purchaser, thereby reducing the purchaser's financial risk. Each of the five illustrative examples is discussed immediately below.

The examples are drawn from the Illinois business opportunity statute. Business Opportunity Sales Law of 1995, 815 ILCS 602/5-1 through 602/5-135 (1995) (“Illinois Act”). Several commenters pointed to that statute as a good model. E.g., Pampered Chef, ANPR 86, at 1; Amway, ANPR 89, at 1; Elman, Sept. 95 Tr. at 132-33; Wieczorek, id. at 284.

i. Location Assistance

The proposed “business assistance” definition would include as an illustrative example the promise to provide locations “for the use or operation of equipment, displays, vending machines, or similar devices on premises neither owned nor leased by the purchaser.” This is substantially similar to the analogous provision in the current Franchise Rule.

Including this example would help ensure that business opportunities currently covered by the Franchise Rule will remain covered by the Business Opportunities Rule. 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.

See

16 CFR at 436.2(a)(1)(ii)(B).

See also

Illinois Act, 815 ILCS 602/5-510(a)(1) (“The seller or a person recommended by the seller will provide or assist the purchaser in finding locations for the use or operation of vending machines, rack display cases or other similar devices, on premises neither owned nor leased by the purchaser or seller.”).

E.g., FTC

Am. Entm't Distribs.,

No. 04-22431-CIV-Huck (S.D. Fla. 2004);

FTC

Advanced Pub. Commc'ns Corp.,

No. 00-00515-CIV-Ungaro-Benages (S.D. Fla. 2000);

FTC

Ameritel Payphone Distribs., Inc.,

No. 00-0514-CIV-Gold (S.D. Fla. 2000);

FTC

Mktg. and Vending Concepts,

No. 00-1131 (S.D.N.Y. 2000).

ii. Account Assistance

Another illustrative example of “business assistance” would be “providing, or purporting to provide, outlets, accounts, or customers, including, but not limited to, Internet outlets, accounts, or customers, for the purchaser's goods or services.” As Commission cases have shown, fraudulent promises of assistance in securing accounts are often the linchpin of business opportunity scams such as fraudulent medical billing schemes.

The proposed definition would be similar to the current “account assistance” provision of the Franchise Rule,

100

but would update that provision by specifying that outlets, accounts, or customers include those on the Internet. Accordingly, the offer to provide Web sites or online shopping malls where the seller's products can be sold would also qualify as an offer of account assistance.

101

E.g., FTC

Mediworks, Inc.,

No. 00-01079 (C.D. Cal. 2000);

FTC

Home Professions, Inc.,

No. 00-111 (C.D. Cal. 2000);

FTC

Data Med. Capital, Inc.,

No. SACV-99-1266 (C.D. Cal. 1999).

See also

California Contracts for Seller Assisted Marketing Plans, Cal. Civ. Code at § 1812.201(a)(3) (CA SAMP) (The “seller will buy back or is likely to buy back any product made, produced, fabricated, grown or bred by the purchaser using in whole or in part, the product, supplies, equipment, or services which were initially sold or leased or offered for sale or lease to the purchaser by the seller assisted marketing plan seller”).

104

Cf.

Illinois Act, 815 ILCS at § 5-5.10(a)(5) (attaching coverage where “[t]he seller will refund all or part of the price paid to the seller, or repurchase any of the products, equipment or supplies provided by the seller or a person recommended by the seller, if the purchaser is dissatisfied with the business”).

105

Elman, 21-Aug-97 Tr. at 106-08.

See also

Franchise Rule SBP, 43 FR at 59630-632; 59684-689.

Some commenters questioned whether the making of an earnings claim alone should be sufficient to bring the sale of a business opportunity within the ambit of the Rule, thereby triggering disclosure and other obligations. Pointing to various state business opportunity laws, these commenters contended that the disclosure and other requirements of the proposed Rule should be triggered only if either: (1) The seller guarantees a level of earnings; or (2) the seller represents that the purchaser will earn at least as much as his or her investment.

113

E.g.

, Wieczorek, 20Nov97 Tr at 32-33; Cantone,

id.

at 33; Catalano;

. at 34.

See

Illinois Act, 815 ILCS at § 602/5-5.10(a)(4) (“The seller guarantees that the purchaser will derive income from the business which exceeds the price paid to the seller.”); CA SAMP, Cal. Civ. Code, at § 1812.201(a)(1) (“represented that the purchaser will earn, is likely to earn, or can earn an amount in excess of the initial payment paid by the purchaser for participation in the seller assisted marketing plan”).

Given the prevalence of earnings claims in business opportunity sales, the Commission believes that a broad earnings disclosure requirement is necessary to prevent fraud. Limiting the Rule's coverage to scenarios in which a seller either makes an express earnings guarantee or represents that the purchaser will recoup his or her investment would effectively clear the way for fraudulent sellers to make other types of earnings claims to deceive prospects. We see little difference, for example, between a seller representing that “our purchasers earn $10,000 a month” and “we guarantee you $10,000 a month.” In both instances, prospective purchasers are likely to give the claim significant weight in making their investment decision.

114

See

Grant, 20Nov97 Tr at 40-41 (“I'm concerned that using the word guarantee would be too limiting, that it would actually prevent the FTC going after companies that we are all concerned about for maybe not using the word guaranteeing but in their representations virtually guaranteeing through a variety of implications a level or range that the person can expect.”).

2. An Offer of Business Assistance

Proposed section 437.1(d) brings within the scope of the Rule's coverage those business opportunity sellers that do not make earnings claims, but offer business assistance. As one business opportunity representative put it: “[Purchasers are] buying the seller's expertise to an extent. * * * The [sellers] know how to do it and that's why [purchasers are] paying a premium.” Catalano, 20Nov97 Tr at 37.

115

At the same time, the “business assistance” prong of the definition helps to distinguish the sale of a business opportunity from the ordinary sale of goods or services: The proposed definition of “business assistance” is limited to only those situations involving “the establishment or operation of a new business.” Assistance provided by a seller in connection with the sale of off-the-shelf goods, for example, would be excluded. The proposed definition of “business assistance,” therefore, expressly states that “ ‘business assistance’ does not include a written product warranty or repair contract, or guidance in the use, maintenance, and/or repair of any product to be sold by the purchaser or of any equipment acquired by the purchaser.”

115

See also

Christopher, 20Nov97 Tr at 68; Grant,

. at 69.

e. Proposed Section 437.1(e): “Cancellation or Refund Request”

Section 437.3(a)(5) uses the term “cancellation or refund request.” It would require a business opportunity seller to disclose the number of cancellation or refund requests received in the last two years.

116

As explained more fully below, this provision would enable the prospective purchaser to assess previous buyers' satisfaction with the business opportunity purchase. In that regard, it is analogous to the Franchise Rule's disclosure of terminations, cancellations, and non-renewals.

117

Proposed section 437.1(e) would define “cancellation or refund request” broadly to mean “any request to cancel or rescind a business opportunity purchase, or any request to seek a refund, in whole or in part, for a business opportunity purchase, whether or not the purchaser has a contractual right to cancel, rescind, or seek a refund.”

116

Like other provisions of the proposed Rule, this provision would be subject to the Rule's quarterly updating requirement set forth at proposed section 437.3(b). For example, a seller offering business opportunities on November 5, 2006, would disclose the data for the period October 1, 2004 through October 1, 2006, the last eight quarters before the date of disclosure.

See also

proposed section 437.1(p) (defining the term “quarterly” to mean January 1, April 1, July 1, and October 1).

117

See

16 CFR at 436.1(a)(16).

f. Proposed Section 437.1(f): “Designated Person”

The term “designated person” appears in section 437.1(d)(3)(ii), the business assistance element of the proposed “business opportunity” definition. That section specifies that offered business assistance underlying a business opportunity solicitation need not be provided to a purchaser directly by the seller. Rather, a seller who represents that business assistance may or will be provided by a third party, such as a locator or supplier, will still be covered by the Rule and subject to its disclosure requirements and prohibitions.

118

Proposed section 437.1(d)(3)(ii) uses the term “designated person” as a convenient way to refer to any third parties who would provide business assistance to a business opportunity purchaser. Section 437.1(f) would define the term “designated person” to mean “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, including, but not limited to, any person who finds or purports to find locations for equipment.”

118

This approach is consistent with the current Franchise Rule's analogous definitional elements, extending the scope of that rule's coverage to reach transactions in which the franchisor provides to the franchisee the services of a person able to secure the retail outlets, accounts, sites, or locations. 16 CFR at 436.2(a)(1)(ii)(B)(3).

See also

Staff Advisory Opinion, Handy Hardware Centers, Bus. Franchise Guide (CCH) ;¶ 6426 (1980).

122

E.g., FTC

Inspired Ventures, Inc.

, No. 02-21760-CIV-Jordan (S.D. Fla. 2002);

FTC

Inv. Dev. Inc.

, No. 89-0642 (E.D. La. 1989).

The second example incorporates the principle, as expressed in the Interpretive Guides to the Franchise Rule, that “any statements from which a prospective purchaser can reasonably infer that he or she will earn a minimum level of income” constitutes an earnings claims. Such implied claims are at least as likely to mislead prospective purchasers as express claims. The proposed definition includes three specific examples illustrative of this type of earnings claim, as follows: “earn enough to buy a Porsche,” “earn a six-figure income,” and “earn your investment back within one year.”

123

Each of these three illustrative examples imply a minimum value—the cost of the lowest priced Porsche in the first example, at least $100,000 in the second, and an amount equal to the purchaser's initial investment in the third.

124

Accordingly, the proposed language makes it clear that these types of representations are indistinguishable from direct, express earnings claims.

123

See

Interpretive Guides, 44 FR at 49967.

124

See

Interpretive Guides, 44 FR at 59685 n. 486.

i. Proposed Section 437.1(i): “Exclusive Territory”

As discussed below, proposed section 437.5(n) would prohibit misrepresentations concerning exclusive territories. Representations about exclusive territories are material because they purport to assure a purchaser that he or she will not face competition from other business opportunity purchasers of the same type in his or her chosen location, or from the seller offering the same goods or services through alternative channels of distribution. Exclusive territory promises go to the viability of the business opportunity and to the level of risk entailed in the purchase. Indeed, misrepresented territories are commonly made by business opportunity sellers to lure consumers into believing that the offer poses little financial risk.

125

See

Staff Program Review,

supra

note 39, at 39, 57.

E.g., FTC

Vendors Fin. Serv., Inc.

, No. 98-1832 (D. Colo. 1998);

FTC

Int'l Computer Concepts, Inc.

, No. 1:94CV1678 (N.D. Ohio 1994);

FTC

O'Rourke

, No. 93-6511-CIV-Ferguson (S.D. Fla. 1993);

FTC

Am. Safe Mktg.

, No. 1:89-CV-462-RLV (N.D. Ga. 1989).

Proposed section 437.1(i) would define an exclusive territory as follows:

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.

Thus, the definition of “exclusive territory” would reflect the common industry practice of establishing geographically delimited territories—such as a city, county, or state borders—as well as other marketing areas, such as those delineated by population.

126

It includes both representations that other business opportunity purchasers will not be allowed to compete with a new purchaser within the territory, as well as representations that the business opportunity seller itself or other purchasers will not compete with the new purchaser through alternative means of distribution, such as through Internet sales. It also includes implied marketing areas, such as representations that the seller or other operators will not compete with the purchaser, without delineating a specific territory, or stating a vague or undefined territory, such as “in the metropolitan area,” or “in this region.” If false, any of these kinds of representations can mislead a prospect about the likelihood of his or her success.

126

See

UFOC Guidelines, Item 12 Instructions, ii.

j. Proposed Section 437.1(j): “General Media”

The term “general media” appears in proposed section 437.4(b), which prohibits business opportunity sellers from making unsubstantiated earnings claims in the “general media.”

127

Proposed section 437.1(j) would define the term “general media” as follows: “any instrumentality through which a person may communicate with the public, including, but not limited to, television, radio, print, Internet, billboard, Web site, and commercial bulk e-mail.”

128

Thus, the definition includes traditional advertising media, such as television, radio, and newspapers, as well as new technologies such as the Internet (both standard advertisements and pop-up window ads), and Web sites.

129

It also includes commercial bulk e-mail messages that are unsolicited, and often sent to individuals who have not previously expressed an interest in receiving an e-mail from the particular business opportunity seller.

130

127

This proposed provision is based on an analogous provision in the current Franchise Rule. 16 CFR at 436.1(e). The Commission has alleged violations of this provision in numerous cases, for example:

FTC

Wealth Sys., Inc.

, No. CV 05 0394 PHX JAT (D. Ariz. 2005);

U.S.

Am. Coin-Op Servs., Inc.

, No. 00-0125 (N.D.N.Y. 2000);

U.S.

Cigar Factory Outlet, Inc.

, No. 00-6209-CIV-Graham-Turnoff (S.D. Fla. 2000);

U.S.

Emily Water & Beverage Co., Inc.

, No. 4-00-00131 (W.D. Mo. 2000); and

U.S.

Greeting Card Depot, Inc.

, No. 00-6212-CIV-Gold (S.D. Fla. 2000).

128

See

Interpretative Guides, 44 FR at 49984-85 (earnings claims made “for general dissemination” includes “claims made in advertising (radio, television, magazines, newspapers, billboards, etc.), as well as those contained in speeches or press releases.” We also note that the Interpretive Guides recognize several exemptions to the general media claim, such as claims made to the press in connection with bona fide news stories, as well as claims made directly to lending institutions.

. We propose that future Compliance Guides to the new Business Opportunity Rule retain these standard general media claims exemptions.

129

E.g., FTC

Am. Entm't Distribs., Inc.

, No. 04-22431-CIV-Martinez (S.D. Fla. 2004) (challenging earnings claims posted on seller's Web site).

130

See

Informal Staff Advisory 04-2, Bus. Franchise Guides (CCH) ¶ 6522 (2004).

k. Proposed Section 437.1(k): “New Business”

The term “new business” appears in section 437.1(d), setting forth the definitional elements of the term “business opportunity.” As noted above, the proposed “business opportunity” definition includes a “solicitation to enter into a new business” prong in order to distinguish the sale of a business opportunity from the ordinary sale of products and services. Section 437.1(k) would define the term “new business” to mean “a business in which the prospective purchaser is not currently engaged, or a new line or type of business.” Thus, the definition covers not only the establishment of a new business, but also entry into a new “line or type of business.” The intention in including the latter language is to cover sales of business opportunities to persons who may already be in a business. It is reasonable to assume that an existing businessperson could be defrauded like any other consumer when expanding his or her business to include new products or services not currently offered for sale. For example, an existing tire business could purchase a vending machines route, or a beverage vending machine route owner could purchase an envelope stuffing opportunity.

131

In such instances, the veteran businessperson may need the proposed Rule's protections as much as a novice.

131

One commenter questioned whether the Rule should cover existing businesses that seek to expand into new lines of business. Caffey, 20Nov97 Tr at 25-27. In his view, experienced businesses may not need full disclosure, noting that the Commission recognized this point in including a fractional franchise exemption in the Franchise Rule. Id. We disagree. As a preliminary matter, we note that the current Franchise Rule's fractional franchise exemption is very narrow, covering instances where the purchaser has been in the same type of business for more than two years and the parties anticipate sales arising from the relationship will represent no more than 20% of total sales. 16 CFR at 436.2(a)(3)(i) and (h). The fractional franchise exemption's prior experience prerequisite recognizes the fact that, because a businessperson may be experienced in one sector—such as snack vending—does not necessarily mean that he or she is experienced enough to understand the potential for success and the risk of loss in another line of business, such as a greeting card rack display or envelope stuffing. Moreover, we are inclined to believe that a “fractional” exemption is unnecessary in the business opportunity context, given the greatly streamlined disclosure document contemplated by the proposed Rule, since the benefits of disclosure would outweigh the minimal compliance costs.

l. Proposed Section 437.1(l): “Person”

Proposed section 437.1(l) would define the term “person,” a term used in many of the proposed Rule's definitional or substantive provisions.

132

As in the current Franchise Rule, the term would include: “an individual, group, association, limited or general partnership, corporation, or any other entity.”

133

Accordingly, the term “person” is to be read broadly to refer to both natural persons, businesses, associations, and other entities. Where the proposed Rule refers to a natural person only, it uses the term “individual.”

132

E.g.

, sections 437.1(o); 437.5(p).

133

See

16 CFR at 436.2(b).

m. Proposed Section 437.1(m): “Prior Business”

As discussed below, section 437.3(a)(3) of the proposed Rule would require business opportunity sellers to disclose litigation in which they have been involved, in whole or in part, as well as that in which any of their affiliates or any prior businesses have been involved. Proposed section 437.1(m) defines “prior business” as

(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.

Thus, the definition is broader than the definition of “predecessor” found in the UFOC Guidelines, for example, which covers only an entity from whom a seller acquired, directly or indirectly, the major portion of the seller's assets.

134

It includes instances where the seller owned or operated companies that ceased operations. This broader definition is necessary to eliminate a potential loophole that would exist under a more restrictive definition. The Commission's law enforcement experience shows that sellers of fraudulent business opportunities frequently ply their trade through multiple companies simultaneously or sequentially, disappearing in order to avoid detection, and then reemerging in some new form or different part of the country under new names. Accordingly, the broader “prior business” is needed to capture all of a seller's operations that might fall outside a narrower term like “predecessor.”

135

134

See

UFOC Guidelines, Item 1 Instructions, iii.

135

E.g., FTC

Joseph Hayes

, No. 4:96CV06126 SNL (E.D. Mo. 1996);

FTC

O'Rourke

, No. 93-6511-CIV-Ferguson (S.D. Fla. 1993);

FTC

Inv. Dev. Inc.

, No. 89-0642 (E.D. La. 1989).

n. Proposed Section 437.1(n): “Providing Locations, Outlets, Accounts, or Customers”

As noted above, one of the hallmarks of fraudulent business opportunities is the offer to find locations, outlets, or accounts for prospective purchasers. The seller itself may purport to secure locations, or may represent that third parties will do so for the business opportunity purchaser.

136

Proposed section 437.1(n) would make clear that “providing locations, outlets, accounts, or customers” means:

136

See, e.g., FTC

Showcase Distribs., Inc.

, No. 95-1368-PHX-SMM (D. Ariz. 1995) (location assistance found where investor introduced to a third party to secure locations or sites or provided with a list of such persons);

FTC

Jordan Ashley, Inc.

, No. 93-2257-CIV-Nesbitt (S.D. Fla. 1994) (locations assistance found where purchasers referred to a professional locator);

U.S.

Hill

, No. IP-154-CR (S.D. Inc. 1991) (location assistance found, in contempt action, where the promoter permitted investors to find their own locations or engaged the services of independent locating companies, but introduced investors to one or two “favored” locators).

See also FTC

World Traders Ass'n, Inc.

, No. CV05 0591 AHM (CTx) (C.D. Cal. 2005) (assistance in finding businesses to purchase surplus goods).

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; collecting a fee on behalf of one or more locators or lead generating companies; or training or otherwise assisting the prospective purchaser in obtaining his or her own locations, outlets, accounts, or customers.

Accordingly, “providing locations,” for example, includes both an offer to provide locations that have already been found, as well as an offer to furnish a list of potential locations. It includes not only directly furnishing locations, but also recommending to a prospective purchaser specific locators, providing a list of locators who will furnish the locations, and training or otherwise assisting prospects in finding their own locations.

137

The Commission's law enforcement history shows that in either case, misrepresentations of this nature are particularly potent fraudulent devices to which prospective purchasers are susceptible because of their reliance on the seller's expertise in making their investment decision.

138

137

The scope of this definition is consistent with the parallel scope of “location assistance” required for business opportunity coverage by the Franchise Rule.

See

Staff Advisory Opinion 95-10, Bus. Franchise Guide (CC) ¶ 6475 (1995).

138

See, e.g., FTC

Greeting Cards of Am., Inc.

, No. 03-60745-CIV-Gold (S.D. Fla. 2003);

FTC

Home Professions, Inc.

, No. 00-111 (C.D. Cal. 2000);

FTC

Hart Mktg. Enter. Ltd., Inc.

, No. 98-222-CIV-T-23 E (M.D. Fla. 1998);

FTC

Hi Tech Mint Sys., Inc.

, No. 98 CIV 5881 (JES) (S.D.N.Y. 1998);

FTC

Fresh-O-Matic Corp.

, No. 96-CV-315-CAS (E.D. Mo. 1996).

o. Proposed Section 437.1(o): “Purchaser”

Proposed section 437.1(o) would define the term “purchaser” to mean “a person who buys a business opportunity.” By operation of the definition of “person” in section 437.1(l), a natural person, as well as any of various entities, would qualify as a business opportunity purchaser.

139

See

16 CFR at 436.2(b).

p. Proposed Section 437.1(p): “Quarterly”

To ensure accuracy and reliability of disclosures, proposed section 437.3(b) would require sellers to revise their disclosures at least “quarterly.”

140

Proposed section 437.1(p) would set forth a bright line rule that is easy to follow and that would ensure uniformity of disclosures: “quarterly” means “as of January 1, April 1, July 1, and October 1.” Thus, the proposed Rule would require sellers to update their disclosure by those specific dates each year.

140

See

16 CFR at 436.1(a)(22).

q. Proposed Section 437.1(q): “Seller”

Proposed section 437.1(q) defines the term “seller” to mean: “a person who offers for sale or sells a business opportunity.” Like the “purchaser” definition, it contemplates that both natural persons and entities may be business opportunity sellers.

r. Proposed Section 437.1(r): “Written” or “In Writing”

Proposed section 437.1(r) would define the terms “written” or “in writing,” which are used throughout the proposed Rule.

141

The terms are defined to include type-set, word processed, printed, handwritten, and faxed documents. The definition also would include new technologies, such as information stored in computer disks or CD-ROMs, as well as information sent via email or posted on the Internet.

142

Nevertheless, the definition seeks a balance, minimizing compliance costs while preventing fraud. To that end, the definition would make clear that all electronic media must be in a form “capable of being downloaded, printed, or otherwise preserved in tangible form and read,” thus ensuring that a prospective purchaser who receives disclosures electronically can read them, share them with an advisor, and retain them for future use.

141

E.g

, sections 437.2, 437.3(a), 437.4(a).

142

. Franchise Rule NPR, 64 FR at 57333. This proposal would effectively permit business opportunity sellers to comply with the proposed Rule electronically, consistent with the Electronic Signatures in Global and National Commerce Act, 15 U.S.C. 7001.

2. Proposed Section 437.2: The Obligation To Furnish Written Documents

Proposed section 437.2 would set forth the Rule's basic disclosure obligation. It would specify that it is a violation of the Rule and section 5 of the FTC Act for a seller to fail to furnish a prospective business opportunity purchaser with a complete and accurate basic disclosure document containing particular items of material information (section 437.3(a)) and, where applicable, an earnings claim statement (section 437.4(a)). The provision requires that these disclosures must be provided to prospective purchasers “at least seven calendar days before the earlier of the time that the prospective purchaser: (1) Signs any contract in connection with the business opportunity sale; or (2) makes a payment or provides other consideration to the seller, directly or indirectly through a third party.” These two requirements are discussed immediately below.

a. “Seven Calendar Days”

The proposed seven calendar-day timing period is modeled on the current Franchise Rule requirement that franchisors furnish prospective purchasers with a completed copy of the franchise agreement at least five business days (which typically works out to be seven calendar days), before the agreement is executed.

143

The Commission believes that seven calendar days is sufficient to enable a prospective purchaser to review the basic disclosure document and any earnings claims statement, as well as conduct a due diligence review of the offering, including contacting references. Nevertheless, the Commission recognizes that for business opportunity sales—as opposed to more complex franchise sales—a shorter period may be warranted. Accordingly, the Commission solicits comment on whether it should adopt a shorter time period.

143

16 CFR 436.1(g).

See

NASAA, ANPR 120, at 4 (advocating 10 business days); Wieczorek, 21Aug97 Tr at 113-14 (suggesting a seven-day or 10 calendar-day waiting period).

But see

Caffey, ANPR 94, at 2 (opposing any waiting period).

b. Signing a Contract or Making a Payment as the Trigger for the Disclosure Obligation

Proposed section 437.2 would set forth two events before which the seller must furnish disclosures: The execution of any contract in connection with the business opportunity sale, or the payment of any consideration.

144

This provision ensures a uniform standard for determining when sellers must furnish disclosures, while ensuring sufficient time for prospective purchasers to review the sellers' disclosures before putting money at risk. To prevent circumvention of this requirement, section 437.2 clarifies that payment to the seller can be made either directly to the seller or indirectly through a third party, such as a broker or locator.

145

144

This is similar to the comparable Franchise Rule provision. 16 CFR at 436.1(a) and 436.2(g).

145

This proposal is narrower than the original Franchise Rule approach. Under the original Franchise Rule, a franchisor must furnish a disclosure document before the signing of a contract or “the payment by a prospective franchisee, about which the franchisor, franchise broker, or any agent, representative, or employee thereof, knows or should know, of any consideration in connection with the sale or proposed sale of a franchise.” 16 CFR at 436.2(g). Accordingly, a franchisor must furnish the disclosures if it knows or should know that a prospective franchisee is going to pay for required equipment from a third party.

See

Interpretive Guides, 44 FR 49970. To reduce compliance burdens, the proposed Business Opportunity Rule, in contrast, would provide that a seller must provide required disclosure seven calendar days before it actually receives consideration, directly or indirectly from a third party.

3. 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 an initial matter, we note that the proposed Rule specifies that only sellers of business opportunities have an obligation to prepare and furnish a basic disclosure document. Other persons involved in the sale of a business opportunity—such as brokers, locators, or suppliers—would have no obligation to prepare basic disclosure documents or to furnish such documents. The ultimate responsibility to ensure that disclosures are accurately prepared and disseminated would rest with the seller.

146

See

Wieczorek, 20Nov97 Tr at 13. This is the same approach staff has recommended with respect to the Franchise Rule. See Staff Report on the Proposed Revised FTC Franchise Rule, at 85 (Aug. 25, 2004) (“Franchise Rule Staff Report”) (available at

http://www.ftc.gov/os/2004/08/0408franchiserulerpt.pdf

Proposed § 437.3(a) would provide instructions for preparing the basic disclosure document. Specifically, sellers must present the information in “a single written document in the form and using the language set forth in Appendix A to part 437”. The single written document requirement is necessary to ensure that disclosures are not furnished in piecemeal fashion that can easily be overlooked or lost. It

would also prevent a seller from circumventing the Rule by presenting damaging information in a format that is not sufficiently prominent to be noticed and understood, or not readily accessible.

147

By specifying that the basic disclosure document be “in the form and using the language set forth in Appendix A,” the Commission intends to make clear that all of the standard disclosures and other wording shown in Appendix A are to be followed without deviation. Failure to follow Appendix A's form and language would violate the Rule.

147

See

16 CFR at 436.1(a)(21).

Appendix A to part 437 would set forth the required format and language of the disclosure document. It consists of a single page and certain attachments that in some instances may be necessary. Specifically, Appendix A prescribes required introductory identifying information, a standard preamble, and five substantive disclosures: (1) Earnings claims; (2) legal actions; (3) cancellation or refund policy; (4) cancellation or refund request history; and (5) references. Three of these disclosure items—earnings claims, legal actions, and cancellation or refund policy—take the form of a “yes” or “no” check box on the disclosure document. Finally, the seller must include a copy of the basic disclosure document to be signed by the prospect as a receipt. Each of these elements of the required disclosure document is explained in greater detail below.

a. Identifying Information

The basic disclosure document would begin with identifying information about the seller.

148

Proposed section 437.3(a)(1) would specify that the seller must include the seller's name, business address, telephone number, the name of the salesperson offering the opportunity,

149

and the date. This background information is material because it would enable a prospective purchaser to contact the seller and any salesperson for additional information, while providing a written record of who provided the required disclosures and when for law enforcement purposes.

148

See

16 CFR at 436.1(a)(1) (requiring the disclosure of the official name and address of the principal place of business of the franchisor); UFOC Guidelines, Cover Page, at 2; Item 1. The Commission has long recognized the materiality of a business opportunity seller's background information. For example, in the Franchise Rule SBP, the Commission concluded that:

The failure to disclose such material information * * * may mislead the [prospect] as to the business experience of the parties with whom he or she is dealing and * * * could easily result in economic injury to the [prospect] because of the * * * dependence upon the business experience and expertise of the [business opportunity seller].

43 FR at 59642. Other Commission trade regulation rules similarly require identity disclosures.

E.g.

, Wool Products Labeling Rule, 16 CFR at 300.14 (recognizing that names on a label may mislead consumers about the actual manufacturer); Fur Products Labeling Rule, 16 CFR at 301.43 (recognizing that corporate name may mislead consumers about the character of the product).

149

See

D'Imperio, Sept95 Tr at 278 (asserting that disclosure of salesperson is an imperative disclosure).

b. Preamble

After the identifying information, the basic disclosure document would prescribe a preamble that briefly explains the purpose and limitations of the disclosures to prospective purchasers. Specifically, the preamble would state that the information contained in the disclosure document “can help you in deciding whether to purchase a business opportunity.” At the same time, it cautions that “no governmental agency has verified the information.”

150

It also advises prospects to seek more information from the FTC by calling the FTC or visiting the FTC's Web site.

151

It also advises prospects to check for information about additional state law requirements with their state's attorney general office.

150

This is very similar to the current Franchise Rule approach.

See

16 CFR at 436.1(a)(21).

151

The reference to the FTC Web site will further reduce fraud by giving prospects access to a wealth of information about business opportunities, including news releases on individual cases and joint enforcement sweeps, consumer education materials, and Commission reports.

c. “Yes” or “No” Disclosure Items

As noted above, the basic disclosure document would instruct the seller to check a box providing “yes” or “no” as to whether it: (1) Makes earnings claims; (2) has been the subject of legal actions; and (3) offers cancellation or refund rights.

i. Proposed Section 437.3(a)(2): Earnings Claims

Proposed section 437.3(a)(2) would address earnings claims. As discussed further below in connection with section 437.4, the Rule would permit sellers to make an earnings claim, provided there is a reasonable basis for the claim and the seller can substantiate the claim at the time it is made.

152

If the seller makes no earnings claim, then section 437.3(a)(2) would direct the seller simply to check the “no” box. If the seller does make an earnings claim, however, then the Rule would require the seller to check the “yes” box and to furnish the prospective purchaser with an earnings claim statement attached to the basic disclosure document.

153

152

This is consistent with analogous provisions in the Franchise Rule, 16 CFR 436.1(b), (c), and (e), as well as the UFOC Guidelines, Item 19.

153

Business opportunity sellers must also make the following prescribed cautionary statement in close proximity to the “yes” or “no” check boxes: “

Read this statement carefully. You may wish to show this information to an advisor or accountant.

” Obviously, this statement would not apply when a seller checks the “no” box.

ii. 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.

154

Specifically, if the seller or certain persons associated with the seller have been the subject of specific types of actions within the last 10 years, the seller would be required to check the “yes” box. The types of actions covered by this provision include “any civil or criminal actions for misrepresentation, fraud, securities law violations, or unfair or deceptive practices.” Knowledge of actions of this nature against the seller or other persons associated with the seller would obviously affect a prospective purchaser's decision to go forward with the transaction. Moreover, the obligation to disclose these actions is not narrowly confined to the seller in its specific current corporate identity. It extends to any “affiliate or prior business of the seller,” 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,” as well as any of the seller's “employees who are involved in business opportunity sales activities.” If there are no actions to disclose, the seller would simply check the “no” box.

154

This provision is based upon analogous provisions of the original Franchise Rule, 16 CFR 436.1(a)(4), and UFOC Guidelines, UFOC Item 3. In connection with the Franchise Rule, the Commission stated in the Franchise Rule SBP that litigation history is material because it bears on the “integrity and financial standing of the [seller].” 43 FR at 59649.

E.g., FTC

Joseph Hayes,

No. 4:96CV02162SNL (E.D. Mo. 1996) (full disclosure would have revealed prior state fines and injunctions);

FTC

Inv. Dev. Inc.,

No. 89-0642 (E.D. La. 1989) (full disclosure would have revealed arson and insurance fraud convictions).

Disclosure of actions against “any affiliate or prior business of the seller” is necessary to prevent circumvention of the Rule. The Commission's law enforcement experience amply demonstrates that fraudulent business opportunity sellers often operate through multiple related affiliates, or use, sequentially or simultaneously, a variety of corporate identities in order to

avoid detection.

155

The requirement to disclose legal actions against affiliates or prior businesses is designed to thwart such attempts to skirt the Rule.

155

See

discussion of section 437.1(m) (“prior business”) above.

The obligation to disclose prior legal actions reaches “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”

156

to ensure that key officers and sales personnel with prior litigation against them cannot evade the Rule by merely foregoing a formal title. It is the function such individuals perform, not a title, that triggers the proposed Rule's disclosure obligation. In the Commission's experience, there is often little correlation between titles and functions performed in business opportunity scams. Business opportunity sellers often operate as a “d/b/a.”

157

Even when a seller operates through a corporation, there often is no compliance with corporate formalities, or other separations of the entity from its owners, and any of the individuals involved in such operations may go on to operate multiple frauds in a variety of corporate formats.

158

Accordingly, any person who acts as a corporate director, officer, or sales manager would be deemed to fall within the ambit of the lawsuit disclosure requirement, whether or not he or she has a formal corporate title.

156

The original Franchise Rule and UFOC Guidelines have comparable disclosure requirements.

See

16 CFR at 436.1(a)(2) and (3) (directors, executives, including the chief executive and chief operating officer, financial, franchise marketing, training and service officers); UFOC Guidelines, Items 2 and 3 (affiliates offering franchises under the franchisor's principal trademark, directors, trustees and/or general partners, the principal officers, and other executives or subfranchisors who will have management responsibility relating to the offered franchises). Cf. Franchise Rule Staff Report, supra note 146, at 101 (recommending that a franchisor identify all individuals who control the franchisor, regardless of any formal title).

157

E.g., FTC

Am. Universal Vending Corp.,

No. 00-0155 (W.D.N.Y. 2000);

FTC

Data Med. Capital, Inc.,

No. SACV-99-1266 (C.D. Cal. 1999).

158

E.g., FTC

Tashman,

318 F.3d 1275 (11th Cir. 2003);

FTC

Inv. Dev. Inc.,

No. 89-0642 (E.D. La. 1989).

The section 437.3(a)(3) litigation disclosure would also extend to the “seller's employees who are involved in business opportunity sales activities.”

159

The Commission's law enforcement experience shows that sales employees, like officers, often make material misrepresentations to induce prospects to purchase a business opportunity.

160

To enable a prospective purchaser to evaluate better such salesperson's statements, the Rule would require a business opportunity seller to disclose certain information about sales personnel's prior adverse legal history.

159

See

D'Imperio, Sept95 Tr at 278 (asserting that salesperson litigation is a critical disclosure).

160

E.g., FTC

Universal Greeting Card Corp.,

No. 02-21753-CIV-Jordan (S.D. Fla. 2002);

FTC

Raymond Urso,

No. 97-2680-CIV-Ungaro-Benages (S.D. Fla. 1997).

See also FTC

America's Shopping Network, Inc.,

No. 02-80540-CIV-Hurley (S.D. Fla. 2002).

The seller, however, would have no obligation to disclose litigation against other employees—secretarial, clerical, and accounting staff, for example. Indeed, because a prospective purchaser typically does not rely on these individuals' expertise, and does not expect these individuals to perform under the business opportunity agreement, any litigation in which they may have been involved is largely immaterial to the business opportunity sale.

To minimize compliance costs, only criminal proceedings or civil actions involving “misrepresentation, fraud, securities law violations, or unfair or deceptive practices” would be disclosed.

161

As previously noted in the discussion of the term “action,” disclosure of such actions is required regardless of whether the claim is brought in a court or administrative action or arbitration proceeding, and whether it is brought by a private party or a governmental agency.

162

The Commission believes that these types of actions are the most relevant in addressing business opportunity fraud.

163

161

This is narrower than the range of actions that must be disclosed under the Franchise Rule.

See

16 CFR at 436.1(a)(4) (legal actions that must be disclosed include embezzlement, fraudulent conversion, misappropriation of property, and actions filed by franchisees involving the franchise relationship).

See also

UFOC Guidelines, Item 3 (franchise, antitrust, or securities law, fraud, unfair or deceptive practices, or comparable allegations). One commenter suggested that the enumerated list of legal actions that must be disclosed in the Franchise Rule context may be unwarranted for business opportunities. We agree.

See

Wieczorek, 21Aug97 Tr at 124 (suggesting that disclosure of embezzlement, fraudulent conversion, and restraint of trade litigation for business opportunities may go too far).

162

The proposed disclosure of legal actions is broader than the comparable disclosure under the Franchise Rule in one respect. The proposed Rule contemplates that a business opportunity seller must disclose prior suits even if the seller prevailed. In contrast, franchisors need not disclose isolated instances of suits in which they prevailed if such suits are not material.

See

16 CFR at 436.1(a)(4)(ii) (only material individual civil actions need be listed). With respect to business opportunities, the filing of a suit for fraud or misrepresentation, for example, is likely to indicate discontent with the business opportunity seller, which is a material fact needed for a prospective purchaser to assess the quality of the relationship between the seller and prior purchasers. In that regard, it is comparable to the disclosure of requests for cancellation or refund, even if the sales agreement contemplates no cancellations or refunds, addressed below.

See also

16 CFR at 436.1(a)(4)(ii) (requiring disclosure of “any group of civil actions which, irrespective of the materiality of any single such action, in the aggregate is material”).

163

See

Finnigan, 21Aug97 Tr at 123 (observing that litigation disclosures are “crucial information,” but should be limited); Sokol,

id.

(suggesting fraud litigation by an enforcement body should be disclosed).

To minimize compliance costs further, the proposed Rule would not require sellers to detail the nature of each legal action, as in the Franchise Rule.

164

If the seller has litigation to disclose, it need only state in an attachment to the disclosure document the full caption of each legal matter (names of the principal parties, case number, full name of court, and filing date). We note that the disclosure document itself instructs prospects that the legal matters disclosed pertain to “misrepresentation, fraud, securities law violation, or unfair or deceptive practices.” This will provide the prospect with a basic understanding of the subject matter of the action. Armed with the full caption, a prospective purchaser can seek additional information if he or she so chooses.

165

164

Cf.

16 CFR at 436.1(a)(4) (“Such statement shall set forth the identity and location of the court or agency; the date of conviction, judgment, or decision; the penalty imposed; the damages assessed; the terms of the settlement or the terms of the order; and the date, nature, and issuer of each such order or ruling.”).

165

We note that the public's ability to review complaints in legal proceedings has become significantly easier since the advent of the Internet. Many legal documents are now routinely posted on court or related websites.

iii. Proposed Section 437.3(a)(4): Cancellation or Refund Policy

Proposed section 437.3(a)(4) would require sellers to disclose all terms and conditions of any cancellation or refund policy.

166

This pertains to a common practice among business opportunity sellers, namely, offering prospective purchasers the right to cancel or to seek a whole or partial refund.

167

Such

cancellation or refund offers are material to prospective purchasers because they involve the potential risk of the proposed transaction, creating the impression that the business opportunity offer is either risk free or a low financial risk. Indeed, the Staff Program Review found that 24% of business opportunity complaints involved consumers seeking to cancel their purchase (818 of 4512 complaints), and 22% involved a refund policy issue (752 of 4512 complaints).

168

166

The Commission adopted the same approach in the TSR.

See

16 CFR at 310.3(a)(1)(iii) (If a seller makes a representation about a refund policy, it must disclose “a statement of all material terms and conditions of such policy.”).

See also

Cecal, 21Aug97 Tr at 126 (suggesting there should be a refund policy statement).

167

See, e.g., FTC

AMP Publ'n., Inc.,

No. SACV-00-112-AHS-ANx (C.D. Cal. 2001);

FTC

Home Professions, Inc.,

No. SACV 00-111 AHS (Eex) (C.D. Cal. 2001);

FTC Innovative Prods.,

No. 3:00-CV-0312-D (N.D. Tex. 2000);

FTC

Encore Networking Servs.,

No. 00-1083 WJR (AIJx) (C.D. Cal. 2000);

FTC

Mediworks, Inc.

No. 00-01079 (C.D. Cal. 2000). Indeed, allegations that business opportunity sellers misrepresented their refund policies ranks among the top 10 complaint allegations in

Commission business opportunity cases brought under Section 5.

See

Staff Program Review,

supra

note 39, at 39.

168

Staff Program Review,

supra

note 39, at 57.

The proposed Rule does not require any seller to offer cancellation or a refund. Rather, if a seller does make a cancellation or refund offer, it must disclose the terms and conditions prior to the sale. Specifically, a seller that offers a cancellation or refund policy must check the “yes” box on the disclosure document and also must attach to the disclosure document a written description of its policy. To minimize compliance costs, the seller may comply with this disclosure by attaching to the disclosure document a copy of a pre-existing document that details the seller's cancellation or refund policy. For example, a seller may detail its refund policy in a company brochure. If so, the seller need only attach to the disclosure document the particular page setting forth the refund policy. As in the other examples above, if no cancellation or refund is offered, then the seller need only check the “no” box.

d. Proposed Section 437.3(a)(5): Cancellation and Refund History

In addition to the “yes” or “no” items discussed above, the proposed Rule would require sellers to disclose information about prior cancellation or refund requests. This information is material to prospective purchasers because it goes to the viability of the business, the success of past purchasers, and their satisfaction with the business opportunity. Knowing that a seller has received a large number of cancellation or refund requests would likely influence a prospective purchaser's decision as to whether to go forward with a transaction.

In many instances, business opportunity sellers make false or deceptive claims about the success of prior purchasers.

169

Such claims are similar to false earnings representations in that they imply that the purchaser will also be successful, or, at the very least, that the seller's offer is a safe investment.

170

The most effective measure to combat such practices might be to require a business opportunity seller to disclose the drop-out rate of prior purchasers of the same opportunity within a given time period. Such an approach would be similar to the Franchise Rule requirement of detailed disclosures about the number of existing franchisees, as well as those who have left the system in the previous year.

171

169

E.g., FTC

Trek Alliance, Inc.,

No. 02-9270 SJL (AJWx) (C.D. Cal. 2002);

FTC

2Xtreme Performance Int'l, LLC,

No. JFM 99CV 3679 (D. Md. 1999);

In re Computer Bus. Servs.,

FTC C-3705 (1996);

FTC

Roche, No. SACV

96-481 LHM (Eex) (C.D. Cal. 1996);

FTC

Infinity Multimedia, Inc.,

No. 96-6671-CIV-Gonzalez (S.D. Fla. 1996).

170

Cf.

Franchise Rule SBP, 43 FR at 59670-71 (“statistical information gives [prospects] material information about the size of the * * * system they are contemplating joining and sheds light on the prospect's likelihood of success.”).

171

See

16 CFR at 436.1(a)(16); UFOC Guidelines, Item 20.

See also

Finnigan, 21Aug97 Tr at 167 (identifying success rate of a business opportunity as a “crucial piece of information”). On the other hand, DSA and its members contended that a drop-out rate may be misleading in the multilevel marketing field, where, because of the low entry costs, people may test the waters for a period before deciding whether to continue with the program.

E.g.,

Elman, 21Aug97 Tr at 155-56; 168-69; Brown,

id.

at 157-58, 168. In such circumstances, a drop-out rate disclosure may overstate the difficulty of succeeding in the business.

But see In re Amway,

93 FTC 618 (1979) (ordering Amway to make such a disclosure). The approach taken in the proposed Rule does not require a drop-out rate. Rather than requiring disclosure of a broad drop-out rate, it focuses narrowly on a subset of purchasers who have ceased operations, namely those who have requested to cancel or to obtain a refund.

The Commission recognizes, however, that a business opportunity seller may not have access to detailed information about prior purchasers who have ceased operations. For example, a vending business opportunity seller may have no further contacts with purchasers after locating the machines and, therefore, would not necessarily know if the purchaser subsequently abandons the business. This is in contrast with the typical business format franchise, where the franchisor maintains direct and extensive contacts with its franchisees during the entire course of the franchise relationship. With respect to a typical business opportunity transaction, therefore, the Commission believes it would be impracticable to mandate a drop-out rate disclosure.

In lieu of a drop-out rate, the Commission proposes that sellers disclose cancellation or refund requests

172

made by prior purchasers during the past two years.

173

Specifically, proposed section 437.3(a)(5) would require sellers to state first the number of purchasers of the business opportunity during the two years prior to the date of disclosure.

174

This number would serve as a base line. Second, the seller would disclose the number of those purchasers who, during the same two-year period, asked to cancel their purchase or sought a refund, whether or not the purchaser has the contractual right to receive a cancellation or refund. This two-fold disclosure is reflected in Appendix A to the proposed Rule, setting forth the required format and language of the disclosure requirement.

172

As discussed above, the definition of “cancellation or refund request” is broad, including any request for cancellation or a full or partial refund, whether or not the requester has the contractual right to receive such a remedy.

173

Cf.

Illinois Act, 815 ILCS § 602/5-35(b)(16)(B) (“The names and addresses of purchasers who have requested a refund or rescission from the seller within the last 12 months and the number of those who have received the refund or rescission).

See also

CA BLS, RR 45, at 9 (“If there is a promise to refund if the purchaser is not satisfied with the business opportunity, the number of times this has occurred during a certain period of time is relevant.”).

174

See

Wieczorek, 21Aug97 Tr at 157; Cecal,

id.

at 159.

The Commission believes that this proposed disclosure is narrowly tailored and would impose minimal compliance costs. It does not require a seller to gather statistics about the status of prior purchasers. Rather, the seller need only report the number of sales, as well as the total number of requests for cancellations or refunds that it has received,

175

both of which should be easy to tally. In addition, it would require sellers to disclose only the number of cancellation requests or refunds, not the identity of individual cancellation or refund requesters.

175

For purposes of this disclosure, the term “past two years” means the eight quarters immediately preceding the date of the disclosure document. This would require quarterly updating, consistent with the Rule's general updating provision, discussed below at proposed section 437.3(b).

While the Commission believes that information on refund requests can provide material information on the satisfaction of previous purchasers, it is also aware that it is possible that such a disclosure requirement might cause some sellers to discourage refund requests by not offering refunds or by limiting the situations in which refunds are offered. On the other hand, the absence of a refund provision or the presence of a very restrictive provision might reduce the attractiveness of the offer. Therefore, the Commission invites comment on the likely effect of this provision on the willingness of business opportunity sellers to offer refunds.

e. Proposed Section 437.3(a)(6): References

Proposed section 437.3(a)(6) would require the disclosure of a limited number of prior purchasers as references. As in the current Franchise Rule,

176

the Commission believes that the disclosure of prior purchasers is very important to prevent fraud because it enables prospects to verify the seller's claims independently.

177

Such a disclosure has been required for over 25 years for business opportunities covered by the Franchise Rule.

176

16 CFR at 436.1(a)(16)(iii).

177

See

Franchise Rule SBP, 43 FR at 59673 (The disclosure of current franchisees' names and addresses “will provide prospective franchisees with a means to (a) ascertain the problems confronting franchisees operating under conditions similar to those under which the prospective franchisees would be operating, and (b) verify the representations by the franchisor concerning the franchise”).

Nevertheless, this proposed disclosure was one of the most controversial proposals in the ANPR. Several business opportunity seller representatives asserted that names of prior purchasers are proprietary information, essentially comprising a customer list. They maintained that there are certain fundamental differences between franchises and business opportunities with respect to the sensitivity of such information. They argued that in franchise relationships, franchisees are often subject to supplier agreements that compel them to purchase goods or services from specific sources contractually mandated by the franchisor. Accordingly, competing suppliers would not approach a franchisee listed in a disclosure document as a potential customer. In contrast, the seller of a business opportunity, such as a vending machine route, may supply the purchaser not only with machines, but products to fill the machines. Often, however, there is no ongoing contractual provision limiting the purchaser's source of supplies. A list of prior business opportunity purchasers, therefore, is essentially a list of potential customers.

178

See, e.g.

, Catalano, ANPR 27, at 2-4 (“[U]nscrupulous competitors [with] access to the customer base of legitimate business opportunity sellers * * * would have a ‘field day’ contacting customers of other sellers, attempting to sell them competing products and services.”); Brown, 21Aug97 Tr at 167 (contending that Amway would fight “tooth and nail” to not disclose purchaser information, which it views as its customer list); Silverman 20Nov97 Tr at 222-23.

While the commenters' concern is not without merit, the Commission believes that the value to prospects of information about prior purchasers is so great as to outweigh any potential detriment to sellers jealous of their customer base. First, the only way prospects can reasonably protect themselves from a seller's fraudulent claims is to conduct their own due diligence review of the business opportunity offer by contacting prior purchasers.

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Unlike franchisees identified by a common trademark or trade name, who can be identified by looking in the yellow pages or other business directories, business opportunity purchasers are not readily identifiable. Indeed, many business opportunities are conducted out of the purchaser's home, making them difficult, if not impossible, to find. Under the circumstances, the Commission concludes that a disclosure of references is essential.

179

See

Rabenberg, Sept95 Tr at 105-06 (business opportunity purchaser asserting that the disclosure of names and addresses of existing purchasers is material information needed to conduct a due diligence investigation of the offer); D'Imperio, RR 16, at 3 (priority should be given to mandatory disclosure of reliable contact information).

The Commission has taken care to limit the scope of proposed section 437.3(a)(6). The seller need only disclose the name, city and state,

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and telephone number of each prior purchaser (if fewer than 10), or at least the 10 prior purchasers nearest to the prospective purchaser's location.

181

In order to minimize compliance costs further, the proposed Rule provides an alternative: In lieu of a list of the 10 prior purchasers nearest the prospect, a seller may provide a prospect with a national list of all purchasers.

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For example, the seller making disclosures online could maintain a master list of purchasers on its website that can be updated periodically. This would enable the seller to avoid having to tailor the disclosure to each prospective purchaser. Proposed section 437.3(a)(6) specifies that sellers selecting the national option must insert the words “See Attached List” and attach a list of the references to the disclosure document.

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The proposed Rule would not require the disclosure of prior purchasers' street addresses. The Commission believes that prospects can readily contact a prior purchaser if provided with the prior purchaser's name, city and state, and telephone number. This approach enables prospects to contact references while minimizing the intrusion into prior purchasers' privacy.

181

See

16 CFR at 436.1(a)(16)(iii).

182

See

Catalano, ANPR 27, at 5. Mr. Catalano opposed the required disclosure of prior purchasers. He stated, however, that if the Commission were to mandate such a requirement, then sellers may prefer disclosing a single national reference list to the regulatory burden imposed by compiling individualized reference lists for each prospective purchaser.

Id.

In addition, proposed section 437.3(a)(6) would limit the disclosure of references to those who have purchased the business opportunity within the last three years. The Commission believes that purchasers within the last three years—as opposed to those who purchased the business opportunity earlier than that—are likely to have the most current information about the seller and its business operation. Limiting the disclosure of references to a three-year period will also minimize compliance costs.

Finally, proposed section 437.3(a)(6) would address the privacy concerns raised by the use of purchaser information. As noted above, the proposed Rule would require a seller to disclose the name, city and state, and telephone number of certain purchasers to serve as references. The Commission has concerns about privacy protection with respect to requiring the disclosure of prior purchasers' contact information—notwithstanding the fact that this type of information is often readily available and in the public domain from such sources as telephone directories. To address this concern, the Commission proposes that sellers be required to state the following language clearly and conspicuously in their disclosure document and in immediate conjunction with the list of references: “If you buy a business opportunity from the seller, your contact information can be disclosed in the future to other buyers.”

The Commission seeks comments and suggestions on balancing the need to enable prospective purchasers to verify sellers' claims with privacy concerns. Specifically, the Commission seeks comment on ways that the Commission might achieve availability of independent information about purchasers' experience consistent with protecting those purchasers' privacy. The Commission seeks comment on alternatives, including approaches that may be used by states with business opportunity laws containing reference disclosures. In addition, the Commission seeks comment on whether the Rule should permit purchasers the opportunity to opt-out of the disclosure of their contact information.

f. Proposed Section 437.3(a)(7): Receipt

Proposed section 436.3(a)(7) would set forth a receipt requirement. Specifically, the seller must attach a duplicate copy of the basic disclosure page to be signed and dated by the purchaser. A designation for the signature and date is included at the bottom of the page. This requirement is designed to document proper

disclosure. The receipt is especially important to prove proper disclosure with respect to electronic documents. A seller furnishing disclosures online, either through email or access to a Web site, has the burden of establishing that the prospect was actually able to access the electronic document. Completion and submission of the receipt serves that purpose.

The proposed Rule does not impose any particular method of transmitting the receipt. In order to minimize compliance costs, the Commission believes that the parties should have maximum flexibility to determine the best method for their business opportunity. Accordingly, proposed section 437.3(a)(7) would permit the seller to inform the prospective purchaser how to return the signed receipts, for example, by sending the receipt to a street address, or through email address, or facsimile.

g. Proposed Section 437.3(b): Updating

To ensure that a seller's disclosures are current, proposed section 437.3(b) would require sellers to update their disclosures periodically. Specifically, the provision states that it would be a violation of the Rule for a seller to fail to update the disclosures to reflect any material changes in the information presented in the basic disclosure document on at least a quarterly basis.

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The Commission believes that quarterly updating strikes the right balance between the need for accurate disclosure and the costs and burdens more frequent updating would entail. Nevertheless, proposed section 437.3(b) would include a proviso that would require more frequent updating in one respect: the list of references. Specifically, a seller would be required to update the list of references monthly until such time that it is able to include the full list of 10 purchaser/references. This is particularly necessary for start-up systems that may have few or no prior purchaser references when they commence business opportunity sales. The Commission believes that prospective purchasers' ability to contact at least 10 purchasers in their due diligence investigation of business opportunity offers outweighs any costs of more frequent updating until the list of 10 is compiled.

183

See

16 CFR at 436.1(a)(22).

4. Proposed Section 437.4: Earnings Claims

Section 437.4 of the proposed Rule would address earnings claims.

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For the most part, this section is similar to the parallel section of the Franchise Rule. Like the Franchise Rule, the proposed Rule would not require business opportunity sellers to make an earnings claim. Rather, the disclosure of earnings information is strictly voluntary. Also, like the analogous provision in the Franchise Rule, proposed section 437.4(a) would require a seller making an earnings claim to: (1) Have a reasonable basis for the claim at the time the claim is made;

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(2) have in its possession written materials that substantiate the claim at the time the claim is made;

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(3) make the written material available to the prospect and the Commission upon request;

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and (4) furnish the prospect with an earnings claim statement.

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Also, like the Franchise Rule, proposed section 437.4(b) would set forth the requirements for making earnings claims in the general media.

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Finally, proposed section 437.4(d), like the analogous section of the Franchise Rule, would require sellers to notify prospects in writing of any changes in earnings information before the prospect enters into a contract or provides any consideration to the seller, directly or indirectly through a third party.

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At the same time, the proposed Rule would differ from the original Franchise Rule by addressing in proposed section 437.4(c) the use of industry financial or earnings information. Each of these issues is discussed in the following section.

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Commenters widely supported earnings disclosure and substantiation.

E.g.,

Christopher, ANPR 115, at 2; Caffey, ANPR 94, at 2; NASAA, ANPR 120, at 3-4; NCL, ANPR 142; Samson, 21Aug97 Tr at 173; Finnigan,

id.

; Wieczorek, RR 23, at 2-3; NASAA, RR 43, at 2; Simon, Sept95 Tr at 281-82.

Cf.

TSR, 16 CFR at 310.3(a)(2)(vi) (prohibiting misrepresentations abou

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