Business Opportunity Rule

Federal RegisterDec 8, 2011

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FEDERAL TRADE COMMISSION

16 CFR Part 437

RIN 3084-AB04

Business Opportunity Rule

AGENCY:

Federal Trade Commission (FTC or Commission).

ACTION:

Final rule.

SUMMARY:

The Commission is adopting final amendments to its Trade Regulation Rule entitled “Disclosure Requirements and Prohibitions Concerning Business Opportunities” (“Business Opportunity Rule” or “Rule”). Among other things, the Business Opportunity Rule has been amended to broaden its scope to cover business opportunity sellers not covered by the interim Business Opportunity Rule, such as sellers of work-at-home opportunities, and to streamline and simplify the disclosures that sellers must provide to prospective purchasers. The final Rule is based upon the comments received in response to an Advance Notice of Proposed Rulemaking (“ANPR”), an Initial Notice of Proposed Rulemaking (“INPR”), a Revised Notice of Proposed Rulemaking (“RNPR”), a public workshop, a Staff Report, and other information discussed herein. This document also contains the text of the final Rule and the Rule's Statement of Basis and Purpose (“SBP”), including a Regulatory Analysis.

DATES:

The provisions of the final Rule will become effective on March 1, 2012.

ADDRESSES:

Requests for copies of the final Rule and the SBP should be sent to Public Reference Branch, Room 130, Federal Trade Commission, 600 Pennsylvania Avenue NW., Washington, DC 20580. The complete record of this proceeding is also available at that address. Relevant portions of the proceeding, including the final Rule and SBP, are available at

http://www.ftc.gov.

FOR FURTHER INFORMATION CONTACT:

Christine M. Todaro, (202) 326-3711, Division of Marketing Practices, Room H-286, Bureau of Consumer Protection, Federal Trade Commission, 600 Pennsylvania Avenue NW., Washington, DC 20580.

SUPPLEMENTARY INFORMATION:

The final Rule modifies the interim Business Opportunity Rule in two significant ways. First, the final Rule contains an expanded definition of “business opportunity” aimed at extending the scope of the Rule to business opportunities previously not covered, such as work-at-home programs. Second, although the final Rule's scope is broader than the interim Business Opportunity Rule, the compliance burden is reduced. Specifically, in contrast to the extensive disclosures previously required, the final Rule now requires that business opportunity sellers provide prospective customers with a substantially simplified and streamlined one-page disclosure document. The final Rule also adds affirmative prohibitions on misrepresentations and omissions, as well as disclosure requirements for sales conducted in Spanish and other languages besides English.

Statement of Basis and Purpose

Key Terms and Abbreviations Used Throughout This Statement of Basis and Purpose

“Amended Franchise Rule” refers to the amended Franchise Rule published at 72 FR 15444 (Mar. 30, 2007) and codified at 16 CFR 436.

“ANPR” refers to the Trade Regulation Rule on Franchising and Business Opportunity Ventures: Advanced Notice of Proposed Rulemaking, 62 FR 9115 (Feb. 28, 1997).

“Initial Proposed Disclosure Document” refers to the original version of the Disclosure Document that was proposed in the INPR in 2006.

“INPR” refers to the Initial Notice of Proposed Rulemaking for the Business Opportunity Rule, 71 FR 9054 (Apr. 12, 2006).

“Interim Business Opportunity Rule” refers to the Business Opportunity Rule, codified at 16 CFR 437 that is currently in effect and is the subject of these amendment proceedings.

“IPBOR” refers to the Initial Proposed Business Opportunity Rule, which was proposed in the INPR in 2006.

“Macro Report” refers to Macro International, Inc.'s report to the FTC on the Disclosure Form, available at

http://www.ftc.gov/bcp/workshops/bizopps/disclosure-form-report.pdf.

“Original Franchise Rule” refers to the original Franchise Rule published at 43 FR 59614 (Dec. 21, 1978).

“RNPR” refers to the Revised Notice of Proposed Rulemaking for the Business Opportunity Rule, 73 FR 16110 (Mar. 26, 2008).

“RPBOR” refers to the Revised Proposed Business Opportunity Rule, which was proposed in the RNPR in 2008.

“Staff Report” refers to FTC staff's

Staff Report to the Federal Trade Commission and Proposed Revised Trade Regulation Rule

(16 CFR Part 437). The Staff Report is available at

http://www.ftc.gov/os/fedreg/2010/october/101028businessopportunitiesstaffreport.pdf.

“Workshop” refers to the June 1, 2009, public workshop held in Washington, DC, to discuss the proposed Disclosure Document and other aspects of the Business Opportunity Rule.

“Workshop Notice” refers to the

Federal Register

Notice announcing the Workshop, 74 FR 18712 (Apr. 24, 2009).

I. Introduction

A. Overview of the Franchise Rule and the Evolution of the Interim Business Opportunity Rule

1. The Franchise Rule

On December 21, 1978, the Commission promulgated a Trade Regulation Rule entitled “Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures” (the “Original Franchise Rule”), to address deceptive and unfair practices in the sale of franchises and business opportunity ventures.

The Original Franchise Rule covered, in a single Code of Federal Regulations part, both franchises and certain business opportunity ventures. With franchises, the franchisee sells goods or services that are associated with the franchisor's trademark, and the franchisee is subject to significant control by, or receives significant assistance from, the franchisor. The franchisee typically distributes goods or services supplied by the seller or an affiliate and receives accounts or locations in which to conduct the business. By contrast, business opportunities often do not involve a trademark. Vending machines or rack display routes are typical examples of business opportunities. Based upon the original rulemaking record, the Commission found that unfair and deceptive practices were widespread in the sale of franchises and business opportunities, causing serious economic harm to consumers.

43 FR 59614 (Dec. 21, 1978).

The Commission adopted the Original Franchise Rule to prevent unfair and deceptive practices in the sale of franchises and business opportunities through pre-sale disclosure of specified items of material information. The purpose of the Original Franchise Rule was neither to regulate the substantive terms of a franchise or business opportunity agreement nor to regulate the relationship between the seller and the buyer. Rather, it was to ensure that sellers disclose material information to prospective buyers. The Original Franchise Rule was posited on the notion that a fully informed prospective buyer can determine whether a particular offering is in his or her best interest.

The Original Franchise Rule required extensive disclosures on a score of specified topics, such as, information about the seller; the business background of the seller's principals and their litigation and bankruptcy histories; the terms and conditions of

the offer; statistical analyses of existing franchised and company-owned outlets; information about prior purchasers, including the names and addresses of at least 10 purchasers nearest the prospective buyer; and audited financial statements.

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

First, the Original Franchise Rule covered only those opportunities that required a purchaser to make a payment of at least $500 within the first six months of operation. In transactions where a purchaser may incur high financial losses if the seller withholds material information, the benefit for prospective purchasers of the Original Franchise Rule's pre-sale disclosure requirements outweighs the sellers' cost to make those disclosures. By contrast, when the investment required 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 Original Franchise Rule did not reach opportunities that charged lower fees.

Second, the “inventory exemption” excluded certain types of payments from the Original Franchise 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 was to eliminate from Original Franchise Rule coverage many pyramid marketing plans because purchasers of 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.

Third, in addition to franchise opportunities, the Commission focused the Original Franchise Rule on the types of business opportunities that the record showed were likely to result in significant consumer injury, such as vending machines, rack displays, and similar opportunities, which frequently were sold through deceptive conduct. A feature common to these types of opportunities was the promise of assistance in securing locations or accounts. Thus, the Commission incorporated this characteristic into the Original Franchise 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) did not bring a business opportunity within the scope of the Original Franchise Rule's coverage.

In addition to these limits on the scope of the Original 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 Original Franchise Rule's language further limited the scope of coverage. Specifically, the Original Franchise Rule provided that a business opportunity was 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 was to exclude many work-at-home opportunities—such as envelope stuffing and craft assembly ventures—from Original Franchise Rule coverage. In those opportunities, the purchaser typically performs work for the seller or produces various goods for the seller, who then purportedly distributes them to end-users.

In 1995, as part of its systematic review of FTC rules, the Commission published in the

Federal Register

a request for comment on the Original Franchise Rule to determine its continued effectiveness and impact.

Based upon the comments received during the rule review, the Commission tentatively determined to retain the Original Franchise Rule, but sought additional comment on possible amendments. To that end, in February 1997, the Commission published an ANPR, seeking comment on various issues, including whether the Commission should separate the disclosure requirements for business opportunities from those for franchises.

60 FR 17656 (Apr. 7, 1995).

62 FR 9115 (Feb. 28, 1997).

Based upon comments responding to the ANPR, the Commission found that the Original Franchise Rule continued to serve a vital purpose and that pre-sale disclosure was necessary to protect purchasers of franchises and business opportunities from fraudulent and deceptive sales practices. At the same time, however, the Commission agreed with the overwhelming view of the commenters who suggested that there are material differences between franchises and business opportunities and that these two types of distinct business arrangements require separate disclosure approaches. For example, many of the Original Franchise Rule's pre-sale disclosures, in particular those pertaining to the structure of the parties' relationship, do not apply to the sale of most business opportunities because those sales typically involve comparatively simple contracts. In addition, the Commission recognized that the Original Franchise Rule's detailed disclosure obligations may create barriers to entry for legitimate business opportunity sellers.

Accordingly, in 1999, the Commission announced its intention to conduct a separate rulemaking proceeding for business opportunity sales.

64 FR 57296 (Oct. 22, 1999).

Id.

2. The Interim Business Opportunity Rule

Much of the information revealed by the Commission's regulatory review of the Original Franchise Rule highlighted the differences between franchises and business opportunity ventures, and the distinct regulatory challenges presented by these two types of offerings—that franchises typically are expensive and involve complex contractual licensing relationships, while business opportunity sales are generally less costly and involve comparatively simple purchase agreements that pose less of a financial risk to purchasers. Based on the record amassed during the review proceeding, the Commission concluded that the Original Franchise Rule's extensive disclosure requirements imposed unnecessary compliance costs on both business opportunity sellers and buyers, and determined to bifurcate the Original Franchise Rule into two separate parts—one covering the sale of business format franchises

and one to govern the sale of business opportunities. Accordingly, in the ANPR, the Commission solicited

comment on several proposed regulatory modifications, including the creation of a separate trade regulation rule governing the sale of business opportunities.

The industry term “business format franchise” specifically refers to franchises in which franchisees operate under a common trademark or other commercial symbol and are required to adhere to the specific business format or method of doing business prescribed by the franchisor. Business format franchises are commonly called “franchises” by the general public, and the two terms are used interchangeably here.

62 FR at 9115. In response to the ANPR, the Commission received 166 written comments. The staff also held six public workshops on the issues raised in the comments, three of which specifically addressed business opportunities.

Subsequently, the Commission completed all procedural steps prescribed by Section 18 of the FTC Act to finalize the Amended Franchise Rule, along with a Statement of Basis and Purpose, in March 2007.

At that time, the Amended Franchise Rule—no longer covering business opportunities—was codified at Part 436 in Title 16 of the CFR. The Original Franchise Rule with all definitional elements and references regarding business format franchising deleted, was retained and redesignated as Part 437. Part 437 was titled the “interim Business Opportunity Rule.”

The interim Business Opportunity Rule contained no new substantive disclosure requirements or prohibitions, and in all material respects was substantially identical to the Original Franchise Rule. Until the final Rule becomes effective, Part 437 governs sales of non-franchise business opportunities.

72 FR 15444 (Mar. 30, 2007).

For example, references to “franchisor” and “franchisee” used in the Original Franchise Rule were changed in the interim Business Opportunity Rule to “business opportunity seller” and “business opportunity purchaser,” and the Original Franchise Rule's definition of “franchise” was changed to “business opportunity.”

See id.

73 FR 16111, 16112 (Mar. 26, 2008).

B. Rule Amendment Proceedings

1. Initial Notice of Proposed Rulemaking and Initial Proposed Business Opportunity Rule

In 2006, having determined that a separate business opportunity rule was necessary, the Commission published an Initial Notice of Proposed Rulemaking (“INPR”), announcing its intention to proceed with its proposal for a separate Business Opportunity Rule (the “initial proposed Business Opportunity Rule” or “IPBOR”).

The INPR proposed to amend the interim Business Opportunity Rule by updating it, streamlining it, and expanding its scope of coverage.

The IPBOR contained an expansive definition of “business opportunity” that encompassed business opportunities previously covered by the Original Franchise Rule as well as work-at home, medical billing, and multi-level marketing (MLM)

operations. It also eliminated the $500 threshold for Rule coverage.

71 FR 19054 (Apr. 12, 2006).

The INPR also specified the process the Commission would follow in amending the Business Opportunity Rule. Pursuant to the Commission's Rules of Practice, 16 CFR 1.20, the Commission determined to use a modified version of the rulemaking process set forth in section 1.13 of those Rules. Specifically, the Commission announced that it would publish a Notice of Proposed Rulemaking, with a 60-day comment period, followed by a 40-day rebuttal period. In addition, pursuant to Section 18(c) of the FTC Act, the Commission announced that it would hold hearings with cross-examination and rebuttal submissions only if an interested party requested a hearing. The Commission also stated that, if requested to do so, it would contemplate holding one or more informal public workshops in lieu of hearings. Finally, pursuant to 16 CFR 1.13(f), the Commission announced that staff would issue a Report on the Business Opportunity Rule (“Staff Report”), which would be subject to additional public comment. 71 FR at 19079-80.

Multi-level marketing is one form of direct selling, and refers to a business model in which a company distributes products through a network of distributors who earn income from their own retail sales of the product and from retail sales made by the distributors' direct and indirect recruits. Because they earn a commission from the sales their recruits make, each member in the MLM network has an incentive to continue recruiting additional sales representatives into their “down lines.”

See

Peter J. Vander Nat & William W. Keep,

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

21 J. Pub. Pol'y & Marketing 140 (Spring 2002).

Promoters of business opportunities were able to evade coverage under the Original Franchise Rule and the interim Business Opportunity Rule by pricing their offerings opportunities below $500, the monetary threshold of coverage.

Streamlining the interim Business Opportunity Rule and tailoring it to fit business opportunities (as opposed to business format franchises) has been a primary focus of this proceeding. Both the Original Franchise Rule and the interim Business Opportunity Rule require extensive disclosures covering over twenty specified topics. In the INPR, the Commission recognized that these extensive disclosure requirements entail disproportionate compliance costs for sellers of comparatively low-cost business opportunity ventures.

Therefore, the Commission proposed to mitigate the compliance burden by simplifying and streamlining the disclosure requirements.

71 FR at 19057.

Id.

Specifically, the INPR proposed a one-page business opportunity pre-sale disclosure document (the “initial proposed disclosure document”) with only six required material disclosures.

The initial proposed disclosure document was intended to provide prospective purchasers with essential material information they could use in making a purchase decision. The INPR proposed to require sellers to use the exact form and language set forth by the Commission and to include information regarding (1) the seller; (2) earnings claims; (3) legal actions involving the offered business and its key personnel; (4) the existence of cancellation or refund policies; (5) the number of cancellation or refund requests; and (6) references.

71 FR at 19091.

71 FR at 19068.

In response to the INPR, the Commission received more than 17,000 comments, the overwhelming majority of which came from individuals active in the MLM industry.

MLM companies, their representatives and trade associations, as well as individual participants in various MLM plans, expressed grave concern about the burdens the IPBOR would impose on them and urged the Commission to exclude them from the scope of the IPBOR, to implement various safe harbor provisions, and to reduce the required disclosures.

The Commission also received approximately 187 comments, primarily from individual consumers or consumer groups, in favor of the IPBOR.

Only a handful of comments came from non-MLM companies and industry groups, expressing various concerns about obligations that the IPBOR would impose upon them.

None of the comments addressed the form of the initial proposed disclosure document.

Comments responding to the INPR are available at

http://www.ftc.gov/os/comments/businessopprule/index.shtm.

References to INPR comments are cited herein as: Name of the commenter-INPR (

e.g.,

Avon-INPR).

Thousands of comments were form letters submitted by participants in various MLM programs. 73 FR at 16113.

Numerous letters came from individuals having negative experiences with various MLMs. 73 FR at 16113 n.37.

73 FR at 16113.

2. The Revised Notice of Proposed Rulemaking and Revised Proposed Business Opportunity Rule

Based on an extensive review of the comments received in response to the INPR and the Commission's law enforcement history, the Commission issued a revised Notice of Proposed Rulemaking (“RNPR”) on March 28, 2008, that set forth a revised proposed Rule (the “Revised Proposed Business Opportunity Rule” or “RPBOR”) that was more narrowly tailored than the IPBOR.

Id.

at 16110.

In the RNPR, the Commission recognized that there were two main problems with the IPBOR's breadth of coverage. First, the IPBOR would have unintentionally swept in numerous commercial arrangements, including

retail product distribution, training and/or educational organizations, where there was little or no evidence that fraud was occurring.

Recognizing this legitimate concern, the Commission, in the RNPR, proposed to narrow the definition of “business opportunity.” Specifically, the RPBOR provided that the “required payment” prong of the business opportunity definition would not include payments for the purchase of reasonable amounts of inventory at bona fide wholesale prices;

eliminated as an element of the business opportunity definition the making of an earnings claim;

and narrowed the types of “business assistance” that would trigger the business opportunity definition to just those types of assistance that are the hallmark of business opportunity fraud: Location, account, and “buy-back” assistance.

Id.

As one commenter described it, the IPBOR would have swept in traditional arrangements for distribution of “food and beverages, construction equipment, manufactured homes, electronic components, computer systems, medical supplies and equipment, automotive parts, automotive tools and other tools, petroleum products, industrial chemicals, office supplies and equipment, and magazines.” IBA-INPR at 5;

see also

Timberland-INPR (noting that numerous manufacturers structure their retail distribution in this manner).

This amendment was based on concerns raised by some commenters that if a “required payment” did not exclude the purchase of inventory, many traditional product distribution arrangements could be brought within the scope of the Rule. 73 FR at 16113.

This amendment was based on concerns raised by some commenters that a broad range of commercial arrangements easily would fall under the business opportunity definition if the company made some representation about sales or profits sufficient to constitute an earnings claim.

Id.

at 16114;

see also

FTC News Release: FTC Announces “Operation Vend Up Broke” (Sept. 3, 1998),

available at http://www.ftc.gov/opa/1998/09/vendup2.shtm

(FTC and 10 states announce 40 enforcement actions against fraudulent vending business opportunities).

See, e.g., United States

Elite Designs, Inc.,

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

United States.

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 filed 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 Serv. Depot, Inc.,

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

United States

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

Brooks-INPR at 2 (“In my opinion, most MLM firms operate in a deceptive or fraudulent manner”).

PSA-INPR at 3-4; Brooks-INPR at 4; Johnson-INPR at 1.

In the RNPR, the Commission concluded that although there is significant concern that some pyramid schemes may masquerade as legitimate MLMs, assessing the incidence of such practices is difficult and indeed, determining whether an MLM is a pyramid scheme requires a fact-intensive, case-by-case analysis. Further, the record developed was insufficient as a basis for crafting MLM disclosures that would effectively help consumers make an informed decision about the risks of joining a particular MLM.

Based on the record and the Commission's law enforcement experience, the RNPR announced the Commission's determination that it would not be practicable to apply the requirements of the proposed Rule to MLM companies. Drawing on its law enforcement experience, the Commission acknowledged that some MLMs do engage in unfair or deceptive acts or practices, including operating pyramid schemes or making unsubstantiated earnings claims that cause consumer harm. The Commission, however, was not persuaded that workable, meaningful disclosures could be devised that would help consumers identify a fraudulent pyramid scheme. This being the case, the Commission decided that the proposed Rule was too blunt an instrument to alleviate fraud in the sale of MLMs. The Commission therefore determined to continue to challenge unfair or deceptive practices in the MLM industry through law enforcement actions alleging violations of Section 5 of the FTC Act and not through the Business Opportunity Rule. The Staff Report's recommendations were consistent with this decision.

Staff Report at 20.

In response to the Staff Report, the Commission received 24 comments addressing the Commission's decision to narrow the scope of the Rule to avoid broadly sweeping in MLMs. Specifically, 19 comments opposed the Commission's decision,

one commenter agreed with the decision to narrow the scope of the Rule, but suggested modifying the Rule to contain bright line exemptions and to clarify the definition of “required payment,”

and two commenters advocated that the Commission adopt the Rule as recommended.

These included eleven comments submitted by consumer group CAI, as well as comments submitted by PSA and seven individuals. In addition, two individuals submitted comments supporting the statistical analysis provided by CAI President, Jon Taylor.

See

McKee-Staff Report; Ashby-Staff Report.

Tupperware-Staff Report.

DSA-Staff Report; Primerica-Staff Report.

Commenters opposing the decision to avoid sweeping MLMs within the scope of the Rule's coverage set forth the same basic premise—that MLMs frequently misrepresent the level of earnings achieved by their distributors and therefore, should be subject to regulation.

More specifically, many of the commenters advocated that the MLM industry should be required to disclose the average income of their participants.

The Commission has carefully considered the comments submitted in response to the Staff Report on the issue of MLMs. While some of the commenters provided an analysis of the MLM industry with concrete examples of the types of problems that exist within that industry,

many did not. Instead, many commenters expressed in general terms their low opinion of MLMs and their general opinion that MLMs should be regulated.

More to the point, none of the commenters provided persuasive arguments for why the Business Opportunity Rule is the proper vehicle to address the problems they identified within the MLM industry.

See, e.g.,

O'Handley-Staff Report (“I personally believe that this industry is a borderline scam at best and needs MORE oversight than everyone else-NOT LESS.”); Welling-Staff Report (“I find it amazing that * * * the MLM industry has little or no regulations.”).

See, e.g.,

Barrett-Staff Report (FTC should “demand truthful disclosure of income potentials for MLM”); Brooks-Staff Report (MLMs should produce “actual, verifiable data concerning the earnings and losses of their distributors”); CAI-Staff Report at 7-3 (advocating for the disclosure of “information supporting earnings claims”).

See, e.g.,

CAI-Staff Report (reporting research on the MLM industry and quoting representations made by various MLMs).

See, e.g.,

Craig-Staff Report (there is “ample evidence of problems with MLM to warrant inclusion in the rule”); Afoa-Staff Report (commenting on personal experience with one MLM).

Before discussing the comments in further detail, however, one point in the rulemaking record requires clarification. Several comments focused on the

following language contained in the Staff Report: “Two key problems emerged with the IPBOR's breadth of coverage. First, the IPBOR would have unintentionally swept in numerous commercial arrangements where there is little or no evidence that fraud is occurring.”

The commenters suggest, incorrectly, that the quoted language reveals a finding by the Commission that there is little or no evidence of fraud occurring within the MLM industry.

This language, however, referred to a passage from the RNPR that addressed traditional product distribution arrangements, not MLMs.

The Commission has not made a finding that there is little or no evidence of fraud within the MLM industry; to the contrary, it has specifically recognized, through its own law enforcement experience, that some MLMs may be pyramid schemes in masquerade and may make false and unsubstantiated earnings claims.

See, e.g.,

CAI-Staff Report at 1, 10-41; PSA-Staff Report.

CAI-Staff Report at 10-41; PSA-Staff Report (“The basis of the exclusion appears to be the extraordinary claim that there is insufficient evidence of widespread fraud in the multi-level marketing field.”).

Indeed, the language quoted by CAI and PSA contains a footnote referencing the section of the RNPR that discussed traditional product distribution arrangements.

See

Staff Report at 30 (citing 73 FR at 16113).

See

73 FR at 16119;

see also

Staff Report at 20.

In any event, the comments submitted in response to the Staff Report do not persuade the Commission that the Business Opportunity Rule is the proper tool to address these problems.

Two of the affirmative disclosure requirements illustrate the difficulty in applying the Rule to MLMs: (1) The disclosure of substantiation for earnings claims; and (2) the disclosure of references.

Indeed, one commenter recommended a completely separate set of disclosures for MLM opportunities, further suggesting that the Business Opportunity Rule is a poor fit for the MLM industry.

See

Johnson-Staff Report (recommending that the FTC convert its consumer education on investing with an MLM into a series of disclosures that would be MLM-specific).

First, as the Commission has acknowledged, the varied and complex structure of MLMs makes it exceedingly difficult to make an accurate earnings disclosure and likely would require different disclosures for different levels of participation in the company. For instance, it would be difficult to craft an accurate earnings disclosure that would account for “inactive” participants that use their distributorship as a “buyers club” and are interested only in purchasing goods at a wholesale price for their own use.

This problem appears to be unique to MLMs and, so far as the Commission is aware, does not arise in other forms of business opportunities.

See

73 FR at 16120.

Furthermore, it may be difficult to determine retail income if the MLM is not in a position to verify the extent to which a distributor has resold the product at retail, is warehousing the product, or bought the product for his or her own personal consumption. Even where the MLM has policies in place purportedly to ensure that a portion of its distributors' income is derived from retail sales, these policies could go unenforced, or even where ostensibly enforced, could be circumvented by distributors who may have an incentive to “inflate” their retail sales by “certifying” that such sales occurred in order to qualify for higher levels of commissions. In light of these difficulties, and because the comments submitted in response to the Staff Report did not refute these findings, the Commission continues to believe that developing a standard, useful, and understandable earnings disclosure that would apply to both the MLM industry and the other business opportunities covered by the Rule remains elusive.

While CAI presented its proposal for an earnings disclosure, it is clear that the disclosure would be specific to MLMs and would have no application to the other types of business opportunities addressed by the Rule.

See

CAI-Staff Report at 7-33.

Second, the reference disclosure required under the final Rule would make little sense in the MLM context. As the Commission has previously recognized, those prior purchasers appearing on the reference list likely would stand to receive a financial benefit if they could convince a prospect to enroll into their downline.

Under these circumstances, information provided by such a reference might not be a reliable indicator of the potential risk and rewards of enrollment in the MLM.

See

73 FR at 16121.

In response to the Staff Report, the Commission received one comment attempting to refute this reasoning. The commenter argued that, contrary to the Commission's view, prior purchasers would have little incentive to misrepresent the success of the MLM because that incentive would exist only if the prospective purchaser would become part of the prior purchaser's downline, which the commenter implies would not always be the case.

The commenter further argued that the fact that the prospective purchaser had received the disclosure document would indicate that the prospective purchaser had already been recruited, and therefore would be unlikely to face further recruitment by the prior purchaser.

Brooks-Staff Report at 8.

Id.

The Commission finds these arguments unpersuasive. To the extent there is any financial incentive for a reference to puff or exaggerate the benefits of buying into a business, that reference obviously cannot provide a disinterested opinion to the prospect. The MLM model is inherently structured to create financial incentives for distributors to recruit prospects into their downlines.

Thus, those financial incentives are present whenever a potential recruit enquires into the business. To illustrate the point, even dissatisfied distributors have an incentive to refrain from disparaging the MLM because any losses they have suffered could potentially be recouped by the recruitment of the prospect into their downline. Whether they are ultimately successful in their attempt to woo a recruit from another distributor is immaterial; they have every incentive to try.

Multi-level marketing is a business model in which a company distributes products through a network of distributors who earn income from their own retail sales of the product and from retail sales made by the distributors' direct and indirect recruits. Because they earn a commission from the sales their recruits make, each member in the MLM network has an incentive to continue recruiting additional sales representatives into their “down lines.”

See

Vander Nat & Keep, supra note 13.

Comments submitted in response to the Staff Report did not refute these arguments, but actually bolstered them. For instance, one commenter noted that MLM recruiters will often pretend they are wealthy when they are not, simply to entice others to join the MLM.

See

O'Handley-Staff Report at 2;

see also

CAI-Staff Report at 5 (noting that in MLMs, “every major victim is of necessity a perpetrator (recruiter) because to have any hope of recouping their ongoing investments * * * they must recruit others to do what they have done”).

Thus, the Commission continues to believe that the final Rule's reference disclosure would not provide prospective MLM participants with an accurate account of the MLM experience or with information necessary to make an informed purchasing decision. Moreover, these challenges appear to be unique to MLMs, and as far as the Commission is aware, are not inherent in the other types of business opportunities addressed by the final Rule.

Accordingly, while the Commission recognizes that problems may exist within the MLM industry, it continues to find that the Business Opportunity Rule is not the appropriate vehicle through which to address them. Rather, the Commission will continue to challenge unfair or deceptive practices in the MLM industry through Section 5 of the FTC Act. Thus, the final Rule has

been crafted to avoid broadly sweeping in MLMs.

The final Rule, however, does not explicitly exempt MLMs from coverage, but instead contains a narrow definition of “business opportunity.” As discussed in Section III.A.3

infra,

the final Rule's definition of “business opportunity” eliminates two types of business assistance that previously would have triggered the Rule's coverage of MLMs: (1) Tracking or paying commissions or other compensation for recruitment or sales; and (2) providing generalized training or advice for the business. The final Rule is thus more narrowly tailored to those types of deceptive business assistance representations that are the hallmark of fraudulent business opportunity schemes: location, account, and “buy back” assistance. 73 FR at 16123.

2. Streamlined Disclosure Requirements

Although the scope of coverage is broader, the compliance burden is lighter under the final Rule than under the interim Business Opportunity Rule. In contrast to the voluminous disclosures that business opportunity sellers are required to make under the interim Business Opportunity Rule, the final Rule has significantly streamlined the disclosures to focus on the types of information most material to business opportunity purchasers: (1) The seller's identifying information; (2) whether the seller makes an earnings claim;

(3) whether the seller, its affiliates, or key personnel, have been involved in any legal actions;

(4) whether the seller has a cancellation or refund policy; and (5) a list of purchasers who have bought the business opportunity within the previous three years. The final Rule also requires the disclosure of supplementary information that substantiates earnings claims, identifies legal actions, and states the material terms of the seller's cancellation or refund policy. These disclosures are consistent with the Commission's experience concerning common practices in the sale of business opportunities, and the types of information most meaningful to prospective purchasers.

For example, the Commission's experience demonstrates that earnings claims are highly relevant to consumers in making their investment decisions and are often the single most decisive factor in such decisions. Furthermore, the presence of a legal action against the seller or its key personnel may warn the purchaser of potential risk associated with the business opportunity. Information about the seller's cancellation or refund policy is relevant to consumers when weighing their investment risks. Finally, providing the contact information for prior purchasers will allow prospective purchasers to discuss the business opportunity with other purchasers prior to committing themselves to the business opportunity venture.

If the business opportunity seller indicates that it does make earnings claims, then it must complete a separate earnings claim statement setting forth the earnings claim, the number and percentage of purchasers who achieved the represented level of earnings, the date range during which the represented earnings were achieved, and additional information.

If the business opportunity seller indicates that it or its affiliates or key personnel have been subject to legal actions, then it must complete a separate attachment setting forth the full caption of each action, and may choose to include a brief 100-word description of the action.

To fully develop the rulemaking record on business opportunities, in the ANPR, the Commission solicited comment about what pre-sale disclosures would ensure that business opportunity purchasers receive material information necessary to make an investment decision and prevent fraud in the sale of business opportunities. 62 FR at 9121, Questions 15 & 16.

These streamlined disclosure requirements strike the appropriate balance by providing consumers with material information in a straightforward and focused document that will allow them to make informed purchasing decisions. At the same time, the streamlined form eases the compliance burden currently imposed on business opportunity sellers. Like the Original Franchise Rule and the interim Business Opportunity Rule, the final Rule is posited on the notion that a fully informed consumer is in a better position to determine whether a particular offering is in his or her best interest when sellers are required to disclose to them material information. Consumers should be protected against receiving inaccurate information and self-serving unsubstantiated statements from business opportunity sellers. Accordingly, the final Rule requires that business opportunity sellers disclose just the types of information that the Commission has determined are most material to potential purchasers in making a purchasing decision: The seller's identifying information; whether the seller makes an earnings claim, and if so, the substantiation for that claim; whether the seller offers a refund or cancellation policy, and if so, the material terms of that policy; whether the seller or its affiliates and key personnel have been the subject of prior legal actions; and the names and business telephone numbers of prior purchasers to contact. The Commission has determined that these streamlined disclosure requirements will provide potential purchasers with the tools they need to protect themselves from false claims, while at the same time minimizing compliance costs for legitimate business opportunity sellers.

3. Express Prohibitions

In addition to mandating disclosures to prospective purchasers, the final Rule includes prohibitions on sellers from engaging in a number of deceptive practices, which were absent from the interim Business Opportunity Rule. In drafting the final Rule, the Commission relied heavily on its experience in addressing a wide array of deceptive and unfair business opportunity practices through law enforcement actions under the Original Franchise Rule, the interim Business Opportunity Rule, and Section 5 of the FTC Act. The Commission also relied 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.

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 are also prevalent in Commission business opportunity cases.

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

See, e.g., FTC

Darling Angel Pin Creations, Inc.,

No. 8:10-cv-00335-JSM-TGW (M.D. Fla. Feb. 2010) (representing likely earnings of $500 per week);

FTC

Route Wizard, Inc.,

No. 1:06-cv-00815-KD-B (S.D. Ala. 2006) (representing that purchasers could earn $3,000 a month);

FTC

Bus. Card Experts, Inc.,

No. 06-CV-4671 (PJS/RLE) (D. Minn. 2006) (claiming likely earnings of $150,000 in first year);

FTC

Richardson d/b/a Mid-South Distribs.,

No. CV-06-S-4754-NW (N.D. Ala. 2006) (representing likely earnings of over $2,000 a month or $65,000 a year);

FTC

Accent Mktg., Inc., et al.,

No. 02-405-CB-M (S.D. Ala. 2002) (representing likely earnings of $3,200 per month to $16,000 per month).

See, e.g., FTC

Bus. Card Experts, Inc.,

No. 06-CV-4671 (PJS/RLE) (D. Minn. 2006) (used paid references);

FTC

Route Wizard, Inc.,

No. 1:06-cv-00815-KD-B (S.D. Ala. 2006) (misrepresented location assistance);

FTC

Richardson d/b/a Mid-South Distribs.,

No. CV-06-S-4754-NW (N.D. Ala. 2006) (promised high-traffic, high-profit locations);

FTC

Am. Entm't Distribs., Inc.,

No. 04-22431-Civ-Martinez (S.D. Fla. 2004) (used fictitious references, misrepesented locations);

FTC

Fidelity ATM, Inc.,

No. 06-81101-Civ-Hurley/Hopkins (S.D. Fla. 2004) (misrepresented level of support or assistance);

FTC

Accent Mktg., Inc., et al.,

No. 02-405-CB-M (S.D. Ala. 2002) (misrepresented that references purchased the business venture or would provide reliable descriptions of their experience);

FTC

Associated Record Distribs., Inc.,

No. 02-21754-CIV-Graham/Garber (S.D. Fla. 2002) (misrepresented business assistance and that references either purchased the business venture or would provide reliable descriptions of their experience).

In 2010, the Commission logged over 12,000 complaints against franchises, business opportunities, and work-at-home schemes.

See

Consumer Sentinel Network Databook (March 2011) at 76,

available at http://ftc.gov/sentinel/reports/sentinel-annual-reports/sentinel-cy2010.pdf.

Therefore, among other things, under the final Rule, business opportunity sellers are prohibited from misrepresenting: (1) Earnings; (2) the cost, 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) their 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) that the business opportunity is an offer of employment; (8) territorial exclusivity or more limited territorial protections; (9) endorsements; and (10) references. The final Rule also prohibits business opportunity sellers from failing to make promised refunds, and from assigning to any purchaser a purported exclusive territory that has been sold to another purchaser.

The final Rule prohibits entities covered by the Rule from engaging in the specific acts or practices identified as deceptive or unfair through the Commission's law enforcement experience, as well as the rulemaking record. Engaging in any of those acts or practices is a violation of both the final Rule and Section 5 of the FTC Act.

Of course, the Commission, under Section 5, also may challenge any conduct that is not enumerated in the final Rule if the Commission determines that such conduct constitutes an unfair or deceptive act or practice.

15 U.S.C. 57a(d)(3).

4. Disclosures in Spanish or Other Languages Besides English

The Commission's law enforcement history demonstrates that some business opportunities are marketed primarily to Spanish speaking consumers.

Based on this experience, the Staff Report discussed the limited utility of English-language disclosures for business opportunities marketed in Spanish. Specifically, the staff questioned whether the disclosure document could be made more effective by translating it into Spanish and requiring that when a business opportunity is marketed in Spanish, the disclosure document and any disclosures required by the Rule be provided in Spanish. The Staff Report further suggested that when a business opportunity seller purposefully reaches out to a particular population by marketing in the foreign language spoken by members of that community, all of the disclosures required by the Rule should be accessible and comprehensible to each of those potential purchasers. The Staff Report recommended, therefore, that because the Commission has specific law enforcement experience with business opportunities marketed in Spanish, a Spanish translation of the disclosure document was necessary to attach as an appendix to the final Rule. It further recommended that where the business opportunity is marketed in a language other than Spanish, the business opportunity seller should be required to translate the disclosure document into the language of the sale and provide all the disclosures required by the Rule in that language.

E.g., FTC

Zoilo Cruz,

No. 3:08-cv-01877-JP (D. P.R. 2008) (envelope stuffing scheme marketed in Spanish-language newspapers and on a Web site available in Spanish and English);

FTC

Integrity Mktg. Team, Inc.,

No. 07-cv-61152 (S.D. Fla. 2007) (envelope stuffing scheme marketed in Spanish-language classified advertisements);

FTC

Hispanexo, Inc.,

No. 1:06-cv-00424-JCC-TRJ (E.D. Va. 2006) (assistance in starting a construction, gardening, or cleaning business marketed through Spanish-language television and radio stations);

FTC

Juan Matos,

No. 06-61429-CIV-Altonaga (S.D. Fla. 2006) (craft assembly business marketed through Spanish-language advertisements);

FTC

Nat'l Vending Consultants, Inc.,

CV-S-05-0160-RCJ (PAL) (D. Nev. 2005) (deceptively marketed vending machine business opportunities—with many marketing efforts specifically targeting Spanish-speaking consumers);

FTC

Amada Guerra,

No. 6:04-CV-1395 (M.D. Fla. 2004) (product assembly scheme telemarketed to Spanish-speaking consumers);

FTC

USS Elder Enter., Inc.,

No. SACV-04-1039 AHS (Anx) (C.D. Cal. 2004) (work at home assembly scheme offered through Spanish-language newspapers and magazines);

FTC

Esteban Barrios Vega,

No. H-04-1478 (S.D. Tex. 2004) (deceptive product assembly opportunity marketed through Spanish-language newspaper and magazine advertisements).

It is the long-held policy of the Commission that disclosures required by Commission orders, rules, or guides should be made in the predominant language used in the related advertisement or sales material.

100

Upon consideration of this policy, the staff's recommendation, and the rationale for the staff's recommendation, the Commission agrees with the staff's recommendation. Accordingly, the final Rule contains a new provision, § 437.5, which specifies the disclosure requirements for sales conducted in Spanish or other languages besides English.

100

FTC Enforcement Policy Statement Concerning Clear and Conspicuous Disclosures in Foreign Language Advertising and Sales Materials, 16 CFR 14.9.

II. The Legal Standard for Amending the Rule

The Commission is amending 16 CFR Part 437 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.

101

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).

101

16 CFR 1.7, 5 U.S.C. 551

et seq.

The Commission's Rules of Practice further provide that if the Commission determines to promulgate a rule, it shall adopt a Statement of Basis and Purpose (“SBP”), which must address four factors: (1) The prevalence of the acts or practices addressed by the rule; (2) the manner and context in which the acts or practices are unfair or deceptive; (3) the economic effect of the rule, taking into account the effect on small businesses and consumers; and (4) the effect of the rule on state and local laws.

102

In this section, the Commission summarizes its findings regarding each of these factors.

103

102

Rules of Practice, 16 CFR 1.14(a)(1)(i)-(iv). In addition, in accordance with 16 CFR 1.14(a)(1)(v), the regulatory analysis is provided at Section V of this Statement of Basis and Purpose.

103

Support in the record for each factor is set forth in the substantive discussion of each provision of the final Rule.

A. Prevalence of Acts or Practices Addressed by the Rule

The Commission promulgated the Original Franchise Rule in 1978 based upon its finding of prevalent deception in the offer and sale of franchises and business opportunity ventures, leading to significant consumer injury. Since 1995, when the Commission commenced a regulatory review of the Original Franchise Rule to ensure that the Original Franchise Rule continued to serve a useful purpose, the Commission has sought comment several times to ascertain the need for a separate trade regulation rule to address widespread fraud in the sale of business opportunities.

104

See

60 FR at 17657; 62 FR at 9117; 71 FR at 19084; 73 FR at 16133; 74 FR at 18172; 75 FR at 68559.

Throughout the Rule amendment proceedings, the Commission has described its experience in combating a wide array of business opportunity fraud through law enforcement actions. Indeed, the Commission's law enforcement experience in conducting numerous sweeps of the business opportunity industry demonstrates that deceptive and unfair practices in the sale of business opportunities are not only prevalent but persistent.

105

Since 1995, the Commission has conducted more than 18 law enforcement sweeps to combat deceptive business opportunity programs, many

with other law enforcement partners.

E.g.,

Operation Bottom Dollar (2010); Operation Short Change (2009); Project Fal$e Hope$ (2006); Project Biz Opp Flop (2005); Project Busted Opportunity (2002); Project Telesweep (1995); Project Biz-illion$ (1999); Operation Money Pit (1998); Project Vend Up Broke (1998); Project Trade Name Games (1997); and Operation Missed Fortune (1996). In addition to joint law enforcement sweeps, the Commission also targeted specific business opportunity ventures such as envelope stuffing (Operation Pushing the Envelope,

see

FTC News Release: Agencies “Pushing the Envelope” to Protect Consumers (Dec. 16, 2003),

available at http://www.ftc.gov/opa/2003/12/pushenvelope.shtm

); medical billing (Operation Dialing for Deception,

see

FTC News Release: FTC Sweep Protects Consumers from “Dialing for Deception” (Apr. 15, 2002),

available at http://www.ftc.gov/opa/2002/04/dialing.shtm

and Project Housecall,

see

FTC News Release: Bogus Business Opportunity Scams Targeted by FTC (Jan. 28, 1998),

available at http://www.ftc.gov/opa/1998/01/housecal.shtm

); seminars (Operation Showtime,

see

Operation “Show Time” Targets Seminars Selling Fraudulent Business Opportunities and Investments (May 5, 1998),

available at http://www.ftc.gov/opa/1998/05/showtime.shtm

); Internet-related services (Net Opportunities 1998); vending machines (Operation Yankee Trader,

see

FTC News Release: Operation “Yankee Trader” Targets Bogus Vending Machine Business Opportunities (Sept. 11, 1997),

available at http://www.ftc.gov/opa/1997/09/still.shtm

); and 900 numbers (Project Buylines,

see

FTC News Release: Newest Business Opportunity Fraud Is For 900-Number Lines, Warns Federal Trade Commission (March 7, 1996),

available at http://www.ftc.gov/opa/1996/03/buyline.shtm

The Commission has amended the interim Rule to address the sale of deceptive work-at-home schemes, where unfair and deceptive practices have been both prevalent and persistent. These schemes prey upon stay-at-home parents, the physically disabled, those who do not speak English, and others who cannot obtain employment outside of the home. 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 business opportunity purchasers produce, often misrepresenting to purchasers that there is a market for the purchasers' goods and services. In addition, the Commission's law enforcement experience demonstrates that 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. Finally, as the Commission's cases and complaint data demonstrate, con artists who promote fraudulent work-at-home schemes frequently dupe consumers with false earnings claims.

Since 1990 the Commission has brought over 75 work-at-home cases.

106

These actions have targeted a variety of schemes, ranging from envelope stuffing and craft assembly programs, to technology-driven opportunities and medical billing plans.

107

106

Many of these cases were brought in connection with law enforcement sweeps of fraudulent work-at-home and related employment opportunities, including Operation Bottom Dollar (2010); Operation Short Change (2009); Project Fal$e Hope$ (2006); Project Biz Opp Flop (2005); Project Homework (2001); Operation Top Ten Dot Con,

see

FTC News Release: Law Enforcers Target “Top 10” Online Scams (Oct. 31, 2000),

available at http://www.ftc.gov/opa/2000/10/topten.shtm;

and Operation Missed Fortune,

see

FTC News Release: FTC, State Enforcers Target Get-Rich-Quick Self-Employment Schemes (Nov. 13, 1996),

available at http://www.ftc.gov/opa/1996/11/misdfort.shtm.

107

See, e.g., FTC

Real Wealth, Inc.,

10-CV-0060-W-FJG (W.D. Mo. 2010) (envelope stuffing);

FTC

Darling Angel Pin Creations, Inc.,

No. 8:10-cv-00335-JSM-TGW (M.D. Fla. 2010) (craft assembly);

FTC

The Results Group L.L.C,

No. CV 06 2843 PHX JAT (D. Ariz. 2006) (work-at-home involving becoming a Web-based affiliate);

FTC

Mazzoni & Son, Inc.,

No.1:06CV2385 (N.D. Ohio 2006) (medical billing).

Data compiled by the Commission demonstrate the prevalence of work-at-home opportunities that do not deliver the represented level of earnings. Indeed, the Commission's 2005 consumer fraud survey revealed that work-at-home plans from which the respondents who had purchased them did not earn at least half the level of promised earnings ranked fifth in terms of the estimated number of victims and third in terms of estimated number of incidents reported during the year.

108

According to the survey, an estimated 2.4 million individuals experienced work-at-home fraud, and there were an estimated 3.8 million incidents during the one year period surveyed.

109

108

See

Consumer Fraud in the United States: The Second FTC Survey (October 2007) at 22,

available at http://www.ftc.gov/opa/2007/10/fraud.pdf

(studying consumer experience with a variety of products and services, including weight-loss products, foreign lotteries, and prize promotions, among others).

109

Id.

Consumer complaints, survey data, and the Commission's law enforcement experience convince the Commission that deception is prevalent in work-at-home offers. The final Rule's disclosure requirements and prohibitions provide potential work-at-home purchasers with the tools they need to protect themselves from false claims.

In addition to work-at-home opportunities, the final Rule also covers the same types of business opportunities that previously were covered under the Original Franchise Rule and the interim Business Opportunity Rule, such as opportunities involving vending machines, rack displays, Internet kiosks, and the like, which, as the Commission's experience demonstrates, have been a persistently fertile ground for fraud and deception.

110

The Commission has conducted numerous law enforcement sweeps that targeted a wide variety of business opportunity scams involving the sale of vending machines, rack displays, and other opportunities covered by the Original Franchise Rule and the interim Business Opportunity Rule.

111

Consumer complaint data indicates that these types of business opportunities continue to be a significant source of consumer injury.

112

110

See id.

at 16 (reporting that an estimated 800,000 individuals were victims of business opportunity fraud during the year surveyed).

111

E.g.,

Project Fal$e Hope$ (2006) (vending machine and rack display opportunities); Project Biz Opp Flop (2005) (vending machine opportunities); Project Busted Opportunity (2002) (vending machine and rack display opportunities); Project Biz-illion$ (1999); Operation Money Pit (1998) (rack display opportunities); Project Vend Up Broke (1998) (vending machine opportunities); Project Trade Name Games (1997) (rack display opportunities); Operation Missed Fortune (1996); Project Telesweep (1995) (vending machine and rack display opportunities);

see also supra

note 55.

112

See

Consumer Sentinel Network Databook (March 2011) at p. 76,

available at http://ftc.gov/sentinel/reports/sentinel-annual-reports/sentinel-cy2010.pdf

(reporting that in 2010, over 12,000 complaints were filed against franchises, business opportunities, and work-at-home schemes).

B. Manner and Context in Which the Acts or Practices Are Deceptive or Unfair

The final Rule has been carefully crafted to address common deceptive or unfair practices engaged in by fraudulent business opportunity sellers.

113

By far, the most frequent allegations in the Commission's business opportunity cases pertain to inducing consumers to pay significant amounts of money by means of false or unsubstantiated earnings claims.

114

This is followed by inducement through false testimonials or fictitious references and by misrepresentations concerning: The profitability of locations; the availability of assistance; the nature of the products or services being sold; the prior success of third-party entities in finding successful locations; the full extent of

the investment costs; and refund policies.

115

The numerous business opportunity complaints that consumers submit to the Commission each year consistently reference these same concerns. The disclosure requirements under the final Rule address each of these deceptive or unfair practices.

113

An act or practice is deceptive under Section 5(a) if it involves a material representation or omission that is likely to mislead consumers, acting reasonably under the circumstances, to their detriment.

See

FTC Policy Statement on Deception,

appended to Cliffdale Associates, Inc.,

103 F.T.C. 110, 174 (1984). An act or practice is unfair under Section 5 if: (1) It causes or is likely to cause substantial injury to consumers; (2) the harm to consumers is not outweighed by any countervailing benefits; and (3) the harm is not reasonably avoidable by consumers.

See

FTC Policy Statement on Unfairness,

appended to In re International Harvester,

104 F.T.C. 949, 1062 (1984).

See

15 U.S.C. 45(n).

114

See supra

note 95.

115

See supra

note 96.

1. Earnings Claims

In the Commission's experience, earnings claims are highly material to consumers in making their investment decisions and typically are the single most decisive factor in such decisions. Earnings claims lie at the heart of business opportunity fraud, and are typically the enticement that persuades consumers to invest their money. In the overwhelming majority of the Commission's more than 245 cases against business opportunity sellers, the business opportunity seller has lured unsuspecting consumers through false or deceptive earnings representations. These claims have taken the form of purported historical earnings statistics (

e.g.,

“Our operators have earned $100,000 a year”), as well as wild and unsupported earnings projections (

e.g.,

“You will earn $100,000 in your first year”). Promoters of work-at-home opportunities frequently dupe consumers with false earnings claims. For example, in one recent envelope-stuffing case brought under Section 5 of the FTC Act, the defendants promised purchasers weekly earnings ranging from $1,200 to $4,400.

116

In another case targeting Spanish-speaking consumers, the defendants promised that purchasers could earn $1,400 per week stuffing envelopes from home.

117

Often earnings claims are express, but may be implied. Sellers often convey these false and unsubstantiated earnings claims orally, although it is not unusual for such claims to be in writing. Nor is it unusual for these false earnings claims to contradict inconspicuous disclaimers the seller has hidden in contracts or other printed materials. At any rate, false or unsubstantiated earnings claims are inherently likely to mislead consumers. Certainly, no aspect of the sales transaction is more material than the level of earnings a purchaser can reasonably expect. Moreover, prospective purchasers reasonably interpret earnings claims at face value. Thus, false or unsubstantiated earnings claims are deceptive and unlawful under Section 5 of the FTC Act.

118

116

FTC

Global U.S. Resources,

No. 10-CV-1457 (RNC) (D. Conn. 2010).

117

FTC

Zoilo Cruz,

No. 3:08-cv-01877-JP (D.P.R. 2008).

118

See

FTC Policy Statement on Deception,

appended to Cliffdale Associates, Inc.,

103 F.T.C. 110, 174 (1984).

Under the Original Franchise Rule and the interim Business Opportunity Rule, the Commission sought to ensure the accuracy and reliability of earnings claims, both written and oral, express or implied, by prohibiting sellers from making an earnings claim, unless the seller possessed a reasonable basis for the claim, along with written substantiation for the claim, at the time the claim was made. Sellers were also required to provide prospective purchasers with a separate earnings claims statement that set forth the claim and the substantiation for that claim. The final Rule continues to address false and deceptive earnings claims by requiring business opportunity sellers to disclose whether they make an earnings claim. Sellers who make earnings claims must attach to the required disclosure document an earnings claim statement setting forth the earnings claim, the number and percentage of purchasers who achieved the represented level of earnings, the date range during which the represented earnings were achieved, and other information. These disclosure requirements are designed to help consumers identify and evaluate an earnings claim, if one is made, or to arouse suspicion if an earnings claim is made orally but is disclaimed in writing. The final Rule, in § 437.6(d), also prohibits misrepresenting “the amount of sales, or gross or net income or profits a prospective purchaser may earn, or that prior purchasers have earned.”

2. References

The use of paid references or “shills” is a common practice in the sale of fraudulent business opportunities. In many of the Commission's cases against fraudulent business opportunity sellers, the defendants had offered to provide prospective purchasers with purportedly independent references, who in reality were nothing more than paid shills—individuals who were compensated by the defendants to claim that they were successful operators of defendants' business ventures.

119

The business opportunity sellers, however, had not disclosed to prospective purchasers that the references were paid or otherwise received a benefit for providing a favorable account of the opportunity. The use of fictitious references is an objectionable, but very effective means of misleading consumers about a highly material fact—whether other purchasers have actually achieved earnings as the seller represents, and whether those purchasers' overall experience of operating the business has been positive. When the information a reference provides on these questions is fictitious, a prospective purchaser has no way of knowing the information is false and unreliable. Thus, the use of fictitious references—shills—is a deceptive practice.

120

119

E.g., FTC

Am. Entm't Distribs., Inc.,

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

U.S.

Vaughn,

No. 01-20077-01-KHV (D. Kan. 2001);

FTC

Hart Mktg. Enter. Ltd., Inc.,

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

FTC

Inetintl.com,

No. 98-2140 (C.D. Cal. 1998);

FTC

Infinity Multimedia, Inc.,

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

FTC

Allstate Bus. Consultants Group, Inc.,

No. 95-6634-CIV-Ryskamp (S.D. Fla. 1995).

120

See

FTC Policy Statement on Deception,

appended to Cliffdale Associates, Inc.,

103 F.T.C. 110, 174 (1984).

The Original Franchise Rule and the interim Business Opportunity Rule sought to remedy this deceptive practice by requiring business opportunity sellers to provide prospective purchasers with the names and contact information for at least 10 current purchasers of the opportunity. The final Rule continues to remedy this deceptive practice by requiring a business opportunity seller to disclose a list of all prior purchasers of the business opportunity during the previous three years. The disclosure of prior purchasers is instrumental in preventing fraud because it enables prospective purchasers to independently verify the seller's claims. The final Rule also, in § 437.6(q), prohibits misrepresenting that any person has purchased a business opportunity, or that any person can provide an independent assessment of the offering, when such is not the case.

3. Refund Policies

Fraudulent business opportunity sellers often offer prospective purchasers the right to cancel or to seek a whole or partial refund, but when a purchaser seeks to cancel, he finds there are hidden limitations or conditions on the refund policy. More often, the seller simply ignores the purchaser's request. Thus, refund offers are frequently just illusory, and misleading. Cancellation or refund offers are material to prospective purchasers because they purport to reflect the potential risk of the proposed transaction, and may create the impression that the business opportunity offer is either risk free or a low financial risk. Purchasers reasonably interpret a refund policy to be, in fact, as stated. Thus, representing

an illusory refund policy is deceptive under Section 5 of the FTC Act.

Moreover, the failure to honor refund promises is an unfair practice in violation of Section 5(n) of the FTC Act.

121

It often results in substantial injury to business opportunity purchasers that they cannot reasonably avoid.

122

Moreover, the record is devoid of any evidence suggesting that this harm is outweighed by any countervailing benefits.

121

An act or practice is unfair if it “causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition.” 15 U.S.C. 5(n).

122

See, e.g., In re Orkin Exterminating Co.,

108 F.T.C. 263 (1986), aff'd,

Orkin Exterminating Co.

FTC,

849 F.2d 1354 (11 Cir. 1988).

To remedy this practice, under the Original Franchise Rule and the interim Business Opportunity Rule, it was a violation for a seller to fail to refund a purchaser's funds, in certain instances. The final Rule continues to address this practice. Under § 437.3(a)(4) of the final Rule, a seller is not required to have a refund or cancellation policy. The seller, however, is required to disclose whether it has either a refund or cancellation policy, and if so, the seller must disclose, in an attachment to the disclosure document, the material terms of the policy. Moreover, § 437.6(k) prohibits any misrepresentation of a seller's refund or cancellation policies, and § 437.6(l) prohibits failure to provide a refund or cancellation when the purchaser has satisfied the terms and conditions disclosed.

4. Legal Actions

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 obscure their negative reputation or to avoid alerting consumers of the potential for fraud. This subterfuge is designed to mislead, and actually does mislead prospective business opportunity purchasers about a crucially material fact: The reliability and trustworthiness of the seller with whom the consumer is transacting. It is not unreasonable for a consumer to believe that a seller is as represented; the consumer is not obliged to suspect an apparently legitimate seller has a history of fraud hidden behind multiple defunct or impossible to trace corporate entities. Thus, it is a deceptive practice and a violation of Section 5 for a seller to obfuscate past activities that would alert a prospective purchaser of a likelihood of fraud.

123

See

FTC Policy Statement on Deception,

appended to Cliffdale Associates, Inc.,

103 F.T.C. 110, 174 (1984).

One of the key indicia of a seller's reliability and trustworthiness is whether there have been law enforcement actions or lawsuits for fraud and similar infractions targeting that seller. Accordingly, under the Original Franchise Rule and the interim Business Opportunity Rule, the Commission required sellers to disclose certain legal actions in which they or their principals have been involved. Similarly, the final Rule requires a business opportunity seller to disclose any legal actions that the seller, its affiliates, and certain key personnel have been involved in during the previous ten years involving misrepresentation, fraud, securities law violations, or unfair or deceptive practices, including violations of any FTC Rule. Knowledge of such legal actions against the seller and other key persons associated with the seller is material to a prospective purchaser's decision to go forward with the transaction.

These disclosure requirements are tailored to address common deceptive or unfair practices in the sale of business opportunities, as demonstrated by the Commission's extensive law enforcement experience with business opportunity fraud. In addition to these disclosures, the final Rule requires sellers to disclose certain identifying information about themselves and expressly prohibits a variety of material misrepresentations and omissions that the Commission's experience demonstrates to be most commonly associated with deceptive and unfair practices in the sale of business opportunities.

C. The Economic Effect of the Rule

At every stage of the Rule amendment proceeding, the Commission solicited comment on the economic impact of the Rule, as well as the costs and benefits of each proposed Rule amendment. In issuing the final Rule, the Commission has carefully considered the comments received and the costs and benefits of each amendment. As discussed throughout this SBP, the final Rule's disclosure requirements and specific prohibitions will provide a substantial benefit to consumers weighing the risks of investing their money in specific business opportunity offers. In particular, the mandated disclosures will help consumers evaluate the earnings claims made by a seller, investigate the litigation history of the seller, identify the seller's refund or cancellation policy, and check on the experiences of other purchasers. By providing consumers with access to this information before money changes hands, the final Rule will substantially reduce economic harm caused by misleading sales practices.

The Commission has attempted to reduce sellers' compliance costs wherever possible. In general, compliance with the final Rule's disclosure requirements is significantly less burdensome than with the Original Franchise Rule or the interim Business Opportunity Rule. Most notably, the final Rule streamlines the more than 20 separate categories of disclosures required by the interim Business Opportunity Rule to just five. The final Rule also employs specific prohibitions in place of affirmative disclosures wherever possible in an attempt to further reduce compliance costs.

A variety of other amendments have been made in an attempt to reduce compliance costs for business opportunity sellers. For example, in the RNPR, the Commission eliminated the requirement that sellers disclose the litigation histories of their sales personnel, recognizing that such disclosure would place a burden on business opportunity sellers that would not be outweighed by countervailing benefits to prospective purchasers.

124

The final Rule also does not require sellers with prior legal actions against them to detail the nature of the legal action, but rather, permits sellers to provide a brief 100-word description of the case if they so choose. Also, in an attempt to reduce compliance costs, the final Rule permits sellers to comply with the cancellation or refund disclosure requirement by attaching to the disclosure document a copy of a pre-existing document—such as a company brochure—that details the seller's cancellation or refund policy. The final Rule also provides sellers with a less burdensome means of complying with the reference disclosure requirement: 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. For example, a seller making disclosures online could simply maintain an electronic list of purchasers that it updates periodically. This would enable the seller to avoid having to tailor the disclosure to each prospective

purchaser, thereby further reducing compliance costs.

124

73 FR at 16126. The Commission's decision to narrow the Rule so that MLMs would not be burdened with unworkable disclosure requirements was similarly prompted by concern that any potential benefits would be outweighed by compliance costs.

Id.

at 16119-21.

D. The Effect of the Rule on State and Local Laws

Section 437.9(b) of the final Rule provides that the Commission does not intend to preempt state or local business opportunity laws, except to the extent that they conflict with the Rule. A law does not conflict with the Rule if it affords prospective purchasers equal or greater protection, such as a requirement for registration of disclosure documents or more extensive disclosures.

Although state laws offering equal or greater protections are not preempted, § 437.6(c) of the final Rule, which addresses extraneous materials, prohibits sellers from providing disclosures required under state law in the same document with the disclosures required under the final Rule. One of the main goals of revising and tailoring the disclosure requirements for business opportunity sellers is to simplify and streamline the disclosures into a single-page document. The Commission has determined, therefore, that allowing business opportunity sellers to mix federal and state disclosures into one document would be a means for sellers to present lengthy and confusing information to prospective purchasers, and would be contrary to the Commission's goal of requiring sellers to provide a simple, clear, and concise disclosure document.

125

73 FR at 16128.

III. Section-by-Section Analysis of Part 437

The final Rule is divided into ten sections. Section 437.1 defines 19 key terms employed in the Rule's text. Section 437.2 establishes 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 specifies the content and form of the disclosure document. Section 437.4 sets forth the requirements that business opportunity sellers must follow if they elect to make representations regarding earnings. Section 437.5 addresses sales conducted in Spanish or other languages besides English, and the disclosure requirements for those sales. Section 437.6 prohibits a number of specific deceptive claims and other deceptive practices in connection with business opportunity sales. Section 437.7 sets forth the Rule's recordkeeping provisions. Section 437.8 expressly exempts from the Rule those business arrangements that are covered by the Amended Franchise Rule. Finally, two administrative sections—437.9 and 437.10—address other laws, rules, and orders, and severability. The sections that follow discuss each of these rule provisions in turn.

A. Section 437.1: Definitions

The final Rule begins with a list of defined terms in alphabetical order. In several instances, the final Rule's definitions closely track those contained in the interim Business Opportunity Rule or the Commission's interpretations of the Original Franchise Rule.

126

These include the definitions for the terms “action,” “affiliate,” “disclose or state,” “earnings claim,” “person,” and “written or in writing.” In addition, the final Rule includes definitions for the terms “business opportunity,” “designated person,” “exclusive territory,” “general media,” “new business,” “prior business,” “providing locations, outlets, accounts, or customers,” “purchaser,” “quarterly,” “required payment,” and “seller,” each of which was proposed in the IPBOR and, in certain circumstances, modified in the RPBOR and the proposed Final Rule attached to the Staff Report. Finally, the final Rule includes two new definitions that were recommended in the Staff Report: (1) “Material” and (2) “signature or signed.”

127

Each definition, including the record support for the definition and the Commission's analysis, is addressed below.

126

See

16 CFR 437.1; Final Interpretive Guides (“Interpretive Guides”) accompanying the Original Franchise Rule, 44 FR 49966 (Aug. 24, 1978).

127

At the same time, the final Rule eliminates nine of the interim Business Opportunity Rule's terms and their definitions, which are no longer necessary: “prospective business opportunity purchaser,” “business day,” “time for making of disclosures,” “fractional business opportunity,” “business opportunity broker,” “sale of a business opportunity,” “cooperative association,” “fiscal year,” and “personal meeting.”

1. Section 437.1(a): Action

The term “action” appears in § 437.3(a)(3), which requires business opportunity sellers to disclose material information about the business opportunity seller's litigation history.

128

Specifically, § 437.3(a)(3) of the final Rule requires the disclosure of material information about certain civil or criminal actions within the previous ten years involving the business opportunity seller, its directors, and certain key employees,

129

as well as its affiliates or prior businesses. Information about litigation history based on allegations of misrepresentation, fraud, securities law violations, or unfair or deceptive practices is highly material to assessing investment risk. Discovering that a seller has a history of violating laws and regulations is perhaps the best indication that a particular business opportunity is a high-risk investment.

128

Section 437.3(a)(3) requires disclosure of “any civil or criminal action for misrepresentation, fraud, securities law violations, or unfair or deceptive practices, including violations of any FTC Rule.”

129

The final Rule covers “any sales managers, or any individual who occupies a position or performs a function similar to an officer, director, or sales manager of the seller.”

See

§ 437.3(a)(3)(i)(c).

The definition of “action” is intended to make clear that disclosures involving prior litigation include not only civil actions brought before a court but also matters before arbitrators.

130

It also is intended to make clear that an “action” includes all government actions, including criminal matters and actions brought to enforce FTC Rules, as well as administrative law enforcement actions, such as cease and desist orders or assurances of voluntary compliance.

131

130

71 FR at 19061.

131

Id.

During the Business Opportunity workshop, a panelist representing the DOJ suggested that bankruptcy is another type of legal action that should be disclosed to potential purchasers because a bankruptcy filing could be a red flag warning of potential risk associated with a business opportunity.

132

A panelist from the Maryland Attorney General's Office disagreed, arguing that this additional disclosure would not benefit potential business opportunity purchasers because, in his experience, fraudulent business opportunities do not typically file for bankruptcy protection.

133

Instead, in that panelist's experience, fraudulent business opportunity promoters shutter their premises and reopen as an entirely new fraudulent entity. Another panelist posited that disclosure of the existence of a bankruptcy by the business opportunity or its key personnel was not likely to identify fraudulent or problematic business opportunities that would not already be identified through the existing proposed categories of legal actions.

134

132

Jost, June 09 Tr at 32. A second panelist (Taylor, June 09 Tr at 35), and a commenter (Brooks-Workshop comment) agreed that existence of a bankruptcy might be relevant to a potential purchaser.

133

Cantone, June 09 Tr at 37.

134

MacLeod, June 09 Tr at 33.

The Commission has determined not to include bankruptcy as a type of legal action that a business opportunity seller must disclose. The Commission's law enforcement experience indicates that when targeted by law enforcement,

rather than file for bankruptcy, fraudulent business opportunity sellers tend to vanish and then simply reopen under new company names.

135

Thus, there is little meaningful correlation between filing for bankruptcy and promoting a fraudulent business opportunity. Yet, many legitimate businesses have been forced by circumstances to seek the protection of bankruptcy courts. Therefore, bankruptcy filing would not seem to be a reliable marker for potential fraud, and would not likely help business opportunity purchasers avoid being defrauded. Therefore, the final Rule's definition of action does not contain reference to bankruptcy.

136

135

See, e.g., FTC

Nat'l Vending Consultants, Inc.,

CV-S-05-0160-RCJ-PAL (D. Nev. 2005);

FTC

USA Beverages, Inc.,

CV-05-61682 (S.D. Fla. 2004);

FTC

Allstate Bus. Distribution Ctr., Inc.,

CV-00-10335AHM (C.D. Cal. 2001);

FTC

O'Rourke,

No. 93-6511-Civ-Gonzalez (S.D. Fla. 1993);

FTC

Inv. Dev., Inc.,

1989 U.S. Dist. LEXIS 6502 (E.D. La. June 7, 1989).

136

Similarly, the scope of 437.3(c)(3)(i) has remained unchanged and does not require the disclosure of bankruptcy filings.

Finally, the Staff Report noted that some state administrative proceedings result in parties entering into assurances of voluntary compliance, while other states refer to such orders as assurances of discontinuance. The staff recommended, therefore, adding “assurance of discontinuance” to the categories of legal actions enumerated in the proposed definition. The Commission agrees with the staff's recommendation and the final Rule's definition of “action” now includes that phrase. Accordingly, § 437.1(a) of the final Rule defines “action” as follows: “A criminal information, indictment, or proceeding; a civil complaint, cross claim, counterclaim, or third party complaint in a judicial action or proceeding; arbitration; or any governmental administrative proceeding, including, but not limited to, an action to obtain or issue a cease and desist order, an assurance of voluntary compliance, and an assurance of discontinuance.”

The definition of “action,” as recommended in the Staff Report, received no comment, and the final Rule adopts this definition of “action” as recommended.

2. Section 437.1(b): Affiliate

The term “affiliate” appears in several sections of the final Rule, most notably in § 437.3(a)(3), which requires a business opportunity seller to disclose not only litigation in which the seller was named as a party, but any litigation naming any of the seller's “affiliates” or prior businesses. Section 437.1(b) of the final Rule defines the term “affiliate” to mean: “An entity controlled by, controlling, or under common control with a business opportunity seller.” This definition also covers litigation involving a parent or subsidiary of the business opportunity seller.

The definition of “affiliate,” as proposed in the INPR and RNPR, and recommended in the Staff Report, received no comment, and the final Rule adopts this definition of “affiliate” as recommended.

3. Section 437.1(c): Business Opportunity

The definition of “business opportunity” delineates the scope of the Rule's coverage. Under the final Rule, a “business opportunity” is a commercial arrangement that possesses three required elements. First, a seller must solicit a prospective purchaser to enter into a new business.

137

Second, the prospective purchaser of the business opportunity must make a “required payment.”

138

And third, the seller must represent that the seller or one or more designated persons will provide any of three types of business assistance: (1) Providing locations for the purchaser's use or operation of equipment, displays, vending machines, or similar devices; (2) providing outlets, accounts, or customers to the prospective purchaser; or (3) buying back any or all of the goods or services that the purchaser makes, including providing payment for such services as, for example, stuffing envelopes from the purchaser's home.

137

Section 437.1(j) defines “new business” as “a business in which the prospective purchaser is not currently engaged, or a new line or type of business.”

138

See

§ 437.1(p) (defining “required payment”).

Because this section triggers the strictures and requirements of the Rule, the definition of “business opportunity,” and in particular, its specification of the types of “business assistance” that characterize a covered business, has generated substantial comment throughout this proceeding. After careful consideration of the amassed record, the Commission has crafted the final Rule's business opportunity definition to ensure that it is broad enough to encompass many business opportunities that historically were not covered under the Original Franchise Rule or the interim Business Opportunity Rule, but which have routinely been shown to be associated with unfair or deceptive practices.

139

At the same time, the definition of “business opportunity” has been narrowly tailored to avoid inadvertently sweeping in other business arrangements, such as traditional product distribution. This has been accomplished primarily through narrowing the types of business assistance that will trigger the Rule's coverage from the five categories originally proposed in the IPBOR to the three categories described above.

139

As discussed

supra

in Section I.C, the definition of business opportunity no longer excludes transactions falling below a minimum monetary payment threshold nor does it require that the purchaser of the opportunity sell goods or services directly to end-users other than the business opportunity seller. These changes extend the scope of coverage to many business opportunities that previously escaped coverage.

Consistent with the approach proposed in the RPBOR, the final Rule's definition of business opportunity eliminates two types of business assistance that under the IPBOR would have triggered the Rule's strictures and disclosure obligations: (1) Tracking or paying, or purporting to track or pay, commissions or other compensation; and (2) providing other advice or training assistance. The sections below describe the evolution of the business opportunity definition, including the rationale for eliminating these types of assistance from the definition of business opportunity.

In the IPBOR, the proposed definition of “business opportunity” was designed to be broad enough to cover the sale of virtually any type of business opportunity, including two types in particular that historically had fallen outside the scope of the Original Franchise Rule—work-at-home and pyramid marketing opportunities.

140

As explained more fully in the INPR, the Commission's law enforcement experience and consumer complaints demonstrate that these two types of opportunities are sources of prevalent and persistent problems,

141

which the Commission has traditionally challenged under Section 5 of the FTC Act.

142

140

71 FR at 19059.

141

In 2010, pyramid schemes generated approximately 2,000 consumer complaints, while work-at-home schemes generated over 8,000 complaints.

See

Consumer Sentinel Network Databook (March 2011) at 76, 79,

available at http://ftc.gov/sentinel/reports/sentinel-annual-reports/sentinel-cy2010.pdf.

142

Many of these schemes fell outside the ambit of the Original Franchise Rule because: (1) The purchase price was less than $500, the minimum payment necessary to trigger coverage; (2) required payments were primarily for inventory, which did not count toward the $500 monetary threshold; (3) the scheme did not offer location or account assistance; or (4) the scheme involved the sale of products to the business opportunity seller rather than to end-users.

See

71 FR at 19055, 19059.

In order to reach these two types of opportunities, the INPR proposed a broad definition of “business opportunity” comprised of three

elements: (1) A solicitation to enter into a new business; (2) payment of consideration, directly or indirectly through a third party; and (3) the making of either an “earnings claim” or an offer to provide “business assistance.”

143

The IPBOR's definition of “business assistance” included assistance in the form of “tracking or paying, or purporting to track or pay, commissions or other compensation based upon the purchaser's sale of goods or services or recruitment of other persons to sell goods or services.”

144

The Commission noted that many pyramid schemes offer this type of assistance, purporting to compensate participants not only for their own product sales but also for sales made by their participants' downline recruits.

145

Under the IPBOR, “business assistance” also included providing other advice or training assistance.

146

143

See

71 FR at 19087.

144

Id.

145

Id.

at 19063 & n.106.

146

Id.

at 19087 (IPBOR § 437.1(c)(v)).

In response to the INPR, many commenters argued that the IPBOR would have unintentionally swept in numerous commercial arrangements where there is little or no evidence that fraud is occurring.

147

Several commenters contended that the IPBOR would have regulated a wide range of legitimate and traditional product distribution arrangements that were not associated with the types of fraud that business opportunity laws are designed to remedy. For example, one commenter suggested that the IPBOR could be read to cover product distribution through retail stores simply because the retailer pays for inventory and the manufacturer provides sales training to its retail accounts.

148

The commenter suggested that its business operations would meet the IPBOR's definition of business opportunity because: (1) The “payment” prong of the definition did not exempt voluntary purchases of inventory; and (2) providing retail staff with sales training would have satisfied the “business assistance” prong of the definition.

149

Other commenters noted that even if a company provided no “business assistance,” it easily could have fallen under the “business opportunity” definition if the company made some representation about sales or profits sufficient to constitute an earnings claim.

150

147

See

73 FR at 16113-14.

148

Timberland-INPR at 2.

149

Id.

150

IBA-INPR at 4;

see also

PMI-INPR at 3.

Other commenters in response to the INPR argued that the IPBOR would have been broad enough to cover other types of commercial arrangements, such as bona fide educational programs offered by colleges and universities, the sale of certain books by publishers or book stores, and even the relationship between newspapers and independent carriers who distribute the newspapers to homes and businesses.

151

Recognizing the unintended overbreadth of the Rule to sweep in these types of commercial arrangements as well as the unworkability of applying the Rule to MLMs, the Commission proposed the RPBOR with a narrower definition of “business opportunity.” The RPBOR “business opportunity” definition narrowed the types of “business assistance” that would trigger Rule coverage by deleting from the Rule text: (1) Tracking payments or commissions and (2) providing other advice or training assistance.

152

The RPBOR definition also eliminated the “earnings claim” element from the definition.

153

But for this modification, any business or commercial arrangement that made an earnings claim could have been a “business opportunity,” as defined by the Rule. To avoid transforming common commercial transactions into “business opportunities,” some commenters suggested narrowing the definition of “earnings claim.”

154

In the RNPR, however, the Commission determined that the better approach to address concerns about overbreadth was to tailor the substantive scope of the Rule, in part, by unlinking the definition of “business opportunity” from the making of an earnings claim.

155

The Staff Report recommended that the Commission adopt this modification in the final Rule. No comments received in response to the Staff Report addressed this change.

151

Venable-INPR at 2-3; NAA-INPR at 1-3.

152

In addition, the RPBOR clarified that a “required payment” does not include payments for the purchase of reasonable amounts of inventory at bona fide prices. The final Rule incorporates this clarification.

153

73 FR at 16124.

154

Id.

155

Id.

In the RNPR, the Commission solicited comment as to whether the narrowed Rule would adequately reach the field of business opportunity promoters who are likely to engage in unfair or deceptive practices, and conversely, queried whether the newly-proposed narrowing of the definition, and, hence, the scope of the RPBOR's coverage, was sufficient to exclude from the rule traditional distributor relationships

156

that had been inadvertently swept into the IPBOR.

157

156

For example, commenters to the INPR noted that the IPBOR would cover “manufacturers, suppliers and other traditional distribution firms that have relied on the bona fide wholesale price exclusion to avoid coverage” under the Rule. Sonnenschein-INPR at 1-2. The Cosmetic, Toiletry and Fragrance Association posited that the IPBOR would cover the relationship between a manufacturer and an independent contractor who sells the product to beauty supply companies, salons, and others. CTFA-INPR;

see also

LHD&L-INPR at 2 (noting that the IPBOR could cover the relationship between a manufacturer and a regional distributor of products).

157

73 FR at 16133.

The majority of comments in response to the RNPR focused on whether the revisions to the proposed Rule would capture MLMs.

158

The majority of commenters applauded the Commission's decision to narrow the scope of the rule, while others expressed concern that the MLM industry would continue to be subject to the RPBOR despite the more narrowed definition of “business opportunity.”

159

For example, some commenters expressed concern that the buy-back provision, set forth in § 437.1(c)(3)(iii), would sweep in MLM companies that offer to buy back their distributors' unused inventory.

160

These commenters suggested amending this provision to strike the word “provides” from § 437.1(c)(3)(iii), so that the definition of “business opportunity” would clearly not encompass a return of unused materials or merchandise.

161

158

DSA-RNPR. In addition, the Commission received more than 40 comments from various MLMs that expressed support and concurrence with DSA's comments.

See, e.g.,

Big Ear-RNPR; Jafra Cosmetics-RNPR; Lia Sophia-RNPR; Longaberger-RNPR; Princess House-RNPR; Shaklee-RNPR. Some commenters expressed disappointment that the Commission proposed to exclude MLMs from coverage by the Rule.

See, e.g.,

CAI-RNPR; Durand-RNPR; PSA-RNPR; Aird-RNPR (Rebuttal); Parrington-RNPR. As previously noted, the Commission decided to narrow the scope of the Rule to avoid broadly sweeping in MLMs.

159

See, e.g.,

DSA-RNPR; Avon-RNPR; Bates-RNPR; IBA-RNPR; MMS-RNPR; Mary Kay-RNPR; Melaleuca-RNPR; Primerica-RNPR; Pre-Paid Legal-RNPR; IDS-RNPR; Tupperware-RNPR; Venable-RNPR.

160

DSA requires that its members offer to buy back, at 90% of the salesperson's cost, all resalable inventory and other sales materials. DSA-INPR at 35.

161

DSA-RNPR at 6 n.14 (noting that “the buy-back provision is the cornerstone of the DSA's self regulatory regime and a valuable protection for individual direct sellers”); Mary Kay-RNPR at 6; Babener-RNPR; Melaleuca-RNPR.

The Commission is not persuaded that such a change is necessary. In the RNPR, the Commission made clear that § 437.1(c)(3)(iii) was intended to capture work-at-home business opportunities in which the seller provides the purchaser with some supplies and the purchaser converts those supplies into a product

or other “good” for repurchase by the seller or other person.

162

As the Staff Report noted, it would require a labored reading of this section to suggest that the word “provides” means “to return unused inventory the purchaser bought from the seller but was not able to sell.”

163

Moreover, the Commission has explicitly stated that this provision “would not include the offer to buy back inventory or equipment needed to start a business.”

164

162

See

73 FR at 16123.

163

Staff Report at 34.

164

See

71 FR at 19062.

In addition, some commenters argued that § 437.1(c)(3)(i) would inadvertently cover entities that offer, at no cost to purchasers, the use of office space and equipment for the operation of the purchasers' business.

165

These commenters were concerned that such offers could be construed under § 437.1(c)(3)(i) to be providing “locations for the use or operation of equipment * * * on premises neither owned nor leased by the purchaser.” In the RNPR, the Commission stated that this provision was intended to capture fraudulent vending machine and rack display schemes,

166

as well as schemes where a purchaser is forced to lease office space, telephones and other equipment for operation of his or her business.

167

Noting that the Commission did not intend to capture the incidental use of office space and equipment that the purchaser does not own, lease, or control, and for which the purchaser makes no payment, the Staff Report recommended a slight modification to § 437.1(c)(3)(i), amending it to state: “provide locations for the use or operation of equipment, displays, vending machines, or similar devices, owned, leased, controlled, or paid for by the purchaser.”

168

165

For example, Primerica, an MLM that sells insurance products and services, requires that its regional managers provide at no cost to “downline” sales agents the use of office space, supplies, and equipment (such as computers and printers) for the operation of his or her business. Primerica noted that, as a practical matter, it must require this assistance, as the regulatory structure in which Primerica operates necessitates that regional managers exercise compliance oversight functions with respect to the agents in their downlines. Primerica-RNPR;

see also

Avon-RNPR; Tupperware-RNPR.

166

73 FR at 16123 (citing

FTC

Am. Entm't Distribs.,

No. 04-22431-CIV-Martinez (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)).

167

FTC

Equinox, Int'l,

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

168

The Staff Report recommended that the Commission strike the final clause of this provision of the RPBOR—“on premises neither owned or leased by the purchaser”—noting that the clause is superfluous, as a buyer would never need a seller's assistance in identifying locations that the buyer already owns or leases. The Commission agrees, and the final Rule does not include this language.

No comments responding to the Staff Report addressed this proposal. The Commission adopts the change recommended in the Staff Report. This change clarifies that the third prong of the “business opportunity” definition is triggered only when the seller offers to provide the purchaser, directly or through an intermediary, with locations in which to place equipment, displays, vending machines, or similar devices that the purchaser controls. This change will not compromise the long-standing coverage of the Rule, and will allow legitimate sellers to offer beneficial assistance to purchasers, at no cost to those purchasers.

169

In the final Rule, a non-substantive change was made to the definition of “business opportunity” proposed in the Staff Report—the colon and number signaling the first element of the definition was moved. This change simply makes the sentence structure parallel.

4. Section 437.1(d): Designated Person

The term “designated person” appears in the definition of “business opportunity” to ensure coverage over those transactions in which a seller refers a purchaser to a third party for the provision of business locations, accounts, or assistance such as buy-back services, as specified in § 437.1(c)(3). That section makes clear that in order to fall within the scope of the business opportunity definition, the business assistance being offered need not be provided to the purchaser by the seller directly. Rather, a seller who represents that business assistance may or will be provided by a third party, such as a locator or a supplier, will still be covered by the Rule. Section 437.1(c)(3) uses the term “designated person” to refer to any third parties who would provide business assistance to a business opportunity purchaser and to close a potential loophole. For example, a fraudulent vending machine route seller would not be able to circumvent the final Rule by representing to a prospective purchaser that a specific locator will place machines for the purchaser.

170

The referral to a third party would be sufficient to bring the transaction within the ambit of the Rule.

171

Section 437.1(d) of the final Rule defines 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.”

172

170

The Commission's law enforcement experience demonstrates that closing this potential loophole is necessary. For example, in

FTC

Greeting Cards of Am., Inc.,

No. 03-60746-CIV-Gold (S.D. Fla. 2003), the FTC alleged that the business opportunity seller represented that a third party locator would secure locations for the prospective purchaser, and the locator failed to do so.

171

See

71 FR at 19064.

172

This approach is consistent with the Amended 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.

See

16 CFR 436.1(j).

One commenter argued that the proposed definition of “designated person” was overbroad and that its application would result in many multi-level marketing opportunities being swept into the Rule.

173

For instance, if an MLM company requires its managers to provide the use of office space, equipment and supplies, and general business advice to new agents (and presumably to describe these types of assistance to prospective purchasers as part of a sales pitch),

174

one could argue that the company would be covered by the Rule.

175

The commenter offered several suggested revisions to resolve this problem, one of which was to specify that “designated person” does not include entities that receive no payment from the purchaser in order to receive the services provided.

176

The Staff Report noted that alternate resolutions were more appropriate—namely the modification to the definitions of “business opportunity” and “providing locations, outlets, accounts, or customers,” and recommended, therefore, that the definition of “designated person” be adopted in the form proposed in the RNPR. No comments in response to the Staff Report addressed this definition, and the final Rule adopts the definition as recommended.

173

Primerica-RNPR at 11.

174

The MLM company compensates managers for this service; there is no cost to down-line agents. Primerica-RNPR at 11.

175

Id.

176

Id.

at 13.

5. Section 437.1(e): Disclose or State

Section 437.1(e) of the final Rule defines “disclose or state” to mean “to give information in writing that is clear and conspicuous, accurate, concise, and legible.”

177

The purpose of this definition is to ensure that a prospective purchaser will receive complete information in a form that a prospective purchaser easily can read. For example, the furnishing of a disclosure document without punctuation or appropriate

spacing between words would not be “clear.” Similarly, required information such as the number and percentage of prior purchasers who obtained a represented level of earnings would not be “conspicuous” if set in small type, printed in a low-contrast ink, or buried amid extraneous information.

177

See

FTC Policy Statement on Deception,

appended to Cliffdale Associates, Inc.,

103 F.T.C. 110, 174 (1984) (discussing the standard for clear and conspicuous disclosures).

The proposed definition of “disclose or state” received no comment. The final definition, therefore, is adopted as proposed.

6. Section 437.1(f): Earnings Claim

The final Rule's key feature is the disclosure document, which provides a potential purchaser of a business opportunity with five items of material information, including written disclosure of all “earnings claims” made by the seller, before the purchaser pays any money or executes a contract. This will allow a potential purchaser to compare a seller's written representations with any oral representations made. The term “earnings claim” is defined in the final Rule as “any oral, written, or visual representation to a prospective purchaser that conveys, expressly or by implication, a specific level or range of actual or potential sales, or gross or net income or profits.”

178

This intentionally broad definition will cover all variations of earnings representations that the Commission's law enforcement experience shows are associated with business opportunity fraud.

179

178

This definition is substantially similar to the Amended Franchise Rule's definition of “financial performance representation,” which is the Amended Franchise Rule's equivalent of an earnings claim.

See

16 CFR 436.1(e).

179

71 FR at 19065.

For illustrative purposes, the definition includes two examples of communications that constitute earnings claims. The first of these examples describes common types of potentially fraudulent earnings claims: “A chart, table, or mathematical calculation that demonstrates possible results based upon a combination of variables.” This example is intended to clarify that sales matrices that purport to show income from an array of “vends” per day from a vending machine, for example, would constitute an “earnings claim” under the final Rule.

180

Id.

The second example incorporates the principle, as expressed in the Interpretive Guides to the Original Franchise Rule, that “any statements from which a prospective purchaser can reasonably infer that he or she will earn a minimum level of income” constitute an earnings claim.

181

Given the prevalence of earnings claims in business opportunity sales, the Commission believes that a broad earnings disclosure requirement is necessary to prevent fraud. Therefore, the final Rule is not limited to express earnings claims, but also includes implied claims. Indeed, such implied claims are at least as likely to mislead prospective purchasers as express claims.

182

The final Rule's 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.” Each of these three illustrative examples implies 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. Accordingly, this language makes clear that these types of representations are indistinguishable from direct, express earnings claims.

181

44 FR at 49982.

182

Interpretive Guides, 44 FR 49966.

Some commenters have argued that the definition of “earnings claim” is overly broad and that the Commission should narrow the definition.

183

Earnings claims, however, lie at the heart of business opportunity fraud and typically entice consumers into investing their money. The Commission has determined that narrowing the definition of “earnings claim” could allow business opportunity sellers to avoid disclosing critical information to prospective purchasers. Accordingly, the definition of “earnings claim,” as proposed in the RPBOR and recommended in the Staff Report, is adopted without change.

183

73 FR at 16124.

7. Section 437.1(g): Exclusive Territory

This term is defined because it is referenced in § 437.6(n), which prohibits misrepresentations concerning territory exclusivity. Representations about exclusive territories are material because they purport to assure a potential purchaser that he or she will not face competition from other purchasers of the same business opportunity in his or her chosen location, or from the seller offering the same goods or services through alternative channels of distribution.

184

Exclusive territory promises go to the viability of the business opportunity and to the level of risk entailed in the purchase.

185

Indeed, misrepresentations about territories have commonly been made by business opportunity sellers to lure consumers into believing that a purchase poses little financial risk.

186

184

See

71 FR at 19065.

185

Id.

186

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).

Section 437.1(g) of the final Rule defines the term “exclusive territory” as “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.” This definition reflects 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.

187

The definition 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.

187

71 FR at 19065.

The definition also covers 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 untrue, any of these kinds of representations can mislead a prospect about the likelihood of his or her success.

188

Id.

The definition of “exclusive territory” received no comment. Accordingly, the definition of “exclusive territory,” as proposed in the RNPR and recommended in the Staff Report, is adopted without change.

8. Section 437.1(h): General Media

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

189

Section 437.1(h) of

the final Rule defines “general media” to mean: “Any instrumentality through which a person may communicate with the public, including, but not limited to, television, radio, print, Internet, billboard, Web site, commercial bulk email, and mobile communications.”

190

Due to the explosive growth of advertising through mobile devices, the Staff Report recommended adding the phrase “mobile communications” to the list of instrumentalities enumerated in the definition.

191

189

This provision is based on an analogous provision in the Amended Franchise Rule, 16 CFR 436.1(e). The Commission has challenged allegedly unsubstantiated earnings claims made through the general media in numerous cases,

e.g., FTC

Wealth Sys., Inc.,

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

United States

Am. Coin-Op Servs., Inc.,

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

United States

Cigar Factory Outlet, Inc.,

No. 00-6209-CIV-Graham-

Turnoff (S.D. Fla. 2000);

United States

Emily Water & Beverage Co., Inc.,

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

United States

Greeting Card Depot, Inc.,

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

190

See

Interpretive Guides, 44 FR at 49984-85 (earnings claims made “for general dissemination” include “claims made in advertising (radio, television, magazines, newspapers, billboards,

etc.

) as well as those contained in speeches or press releases”). The Commission notes 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.

Id.

The Commission has proposed that future Compliance Guides to the new Business Opportunity Rule retain these standard general media claims exemptions.

See

71 FR at 19065.

191

Staff Report at 42-43.

The definition of general media recommended in the Staff Report received no comment. The Commission has determined to adopt the staff's recommendation and has therefore modified the definition of general media to include mobile communications. Moreover, the definition of general media is not intended to contain an exhaustive list of instrumentalities, and other current (and future) types of mass communication could also fall within the general media definition.

9. Section 437.1(i): Material

The term “material” is used in several sections of the final Rule.

192

Section 437.3(a)(4) of the final Rule requires sellers that offer refunds and cancellations to “state all material terms and conditions of the refund or cancellation policy in an attachment to the disclosure document.” The term “material” is also used in other provisions of the Rule. For example, under § 437.2 (the obligation to furnish written documents), it is a violation of the Rule for the seller to fail to disclose the “material” information specified in § 437.3. Section 437.3, in turn, specifies the items of “material” information that must be disclosed. The definition of “material” at § 437.1(i) was added to the final Rule because some workshop participants expressed concern that § 437.3(a)(4) as originally proposed would not provide sellers with sufficient guidance about the types of information that should be disclosed.

193

In the Staff Report, the staff recommended that “material” be defined to mean as “likely to affect a person's choice of, or conduct regarding, goods or services.”

194

This definition is consistent with the definition of “material” used in the Telemarketing Sales Rule (“TSR”).

195

192

See

§§ 437.1, 437.2, 437.3, 437.4, 437.6, 437.7, and 437.8.

193

Morrissey, June 09 Tr at 41; Taylor, June 09 Tr at 43; Cantone, June 09 Tr at 47.

194

Under the TSR, the Commission requires sellers to disclose all material terms and conditions of the seller's refund policy if the seller makes a representation about the refund policy.

See

16 CFR 310.3(a)(1)(iii).

195

See

16 CFR 310.2(q) (defining “material” to mean “likely to affect a person's choice of, or conduct regarding, goods or services or a charitable contribution”);

see also

FTC Policy Statement on Deception,

appended to Cliffdale Associates, Inc.,

103 F.T.C. 110, 174 (1984) (defining “material” misrepresentation or practice to mean “one which is likely to affect a consumer's choice of or conduct regarding a product”).

The definition of “material” recommended in the Staff Report received one comment.

196

The commenter expressed concern that the definition could be used by sellers as a potential loophole. The commenter suggested that the definition effectively would permit a seller to avoid disclosing the information required by the Rule by arguing that such information is not likely to affect a buyer's decision.

197

The commenter further stated that if the Commission retained the recommended definition, the Rule should contain the following language: “Even though this Rule imposes various requirements for specific disclosures, sellers are permitted to dispense with any disclosures which would not be likely to affect a buyer's choice of, or conduct regarding goods or services.”

198

196

Dub-Staff Report.

197

Id.

at 2-3.

198

Id.

at 2.

The Commission disagrees with the commenter. The final Rule mandates the disclosure of certain types of information, which the Commission has determined are material to a purchaser's investment decision.

199

The language the commenter proposes does nothing to close any perceived loophole. The Commission is not persuaded that the commenter's suggested change will improve clarity. In fact, it may obscure the definition. The Commission is persuaded by the Staff Report that a definition of “material” is necessary and adopts the definition as recommended.

199

See supra

Section I.C.2 discussing the five substantive disclosure items and why they are material to consumers.

10. Section 437.1(j): New Business

The term “new business” appears in the first of three definitional elements of the term “business opportunity.”

200

Section 437.1(j) of the final Rule defines “new business” as a “business in which the prospective purchaser is not currently engaged, or a new line or type of business.” Because it is reasonable to assume that a veteran businessperson may need the final Rule's protections as much as a novice,

201

the latter language of the definition covers the sale of business opportunities to persons who may already be involved in some type of business other than that which is being offered by the seller.

202

200

The first of the three definitional elements of a “business opportunity” is a “solicitation to enter into a “new business.” Section 437.1(c)(1). This element distinguishes the sale of a business opportunity from the ordinary sale or products and services. 71 FR at 19066.

201

71 FR at 19066.

202

For example, an existing tire business owner could purchase a vending machine route, or a beverage vending machine route owner could purchase an envelope stuffing opportunity.

The proposed definition of “new business” received no comment. Accordingly, the Commission adopts the definition of “new business,” as proposed in the RNPR and recommended in the Staff Report.

11. Section 437.1(k): Person

Section 437.1(k) of the final Rule defines the term “person,” a term used in many of the final Rule's definitional or substantive provisions.

203

The Staff Report recommended that the term be defined as “an individual, group, association, limited or general partnership, corporation, or any other entity.”

204

203

E.g.,

§§ 437.1; 437.6(q).

204

This definition is consistent with the definition of the term “person” in both the interim Business Opportunity Rule and the Amended Franchise Rule.

See

16 CFR 436.1(n); interim Business Opportunity Rule 437.2(b).

The Commission received no comments related to the proposed definition of “person.” The Commission adopts the definition of “person” as recommended in the Staff Report, with one slight modification. To clarify that the term encompasses entities that are businesses, the Commission added the word “business” to the last clause of the definition. Accordingly, the final Rule defines the term as “an individual, group, association, limited or general partnership, corporation, or any other business entity.”

205

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

206

205

This definition is consistent with the definition of the term “person” in the TSR.

See

16 CFR 310.2(v).

206

71 FR at 19066.

12. Section 437.1(l): Prior Business

The final Rule requires sellers to disclose certain civil and criminal actions against them, including actions against a “prior business of the seller.”

207

Section 437.1(l) of the final Rule defines “prior business” to mean:

207

§ 437.3(a)(3).

(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.

This definition is intended to include not only an entity from which a seller acquired the major portion of the seller's assets, but also businesses that the seller previously owned or operated.

208

A broad definition of “prior business” is necessary to capture all of a seller's prior operations.

209

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 in a different part of the country under new names.

210

The definition thus requires a more complete disclosure of the seller's business history.

208

The definition of prior business is broader than the definition of “predecessor” found in the Amended Franchise Rule, which covers only an entity from which a seller acquired the major portion of the seller's assets.

See

16 CFR 436.1(p).

209

71 FR at 19066.

210

E.g., FTC

Nat'l Vending Consultants, Inc.,

No. 05-0160 (D. Nev. 2005);

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).

The final definition of “prior business” differs from the definition included in the RPBOR.

211

The Staff Report recommended that the definition eliminate a reference to the prior businesses of the seller's key personnel. Namely, the second prong of the original definition defined prior business to include businesses owned or operated by both the seller and the seller's key personnel.

212

The Commission agrees that this change is necessary for two reasons. First, § 437.3(a)(3)(i)(B) requires disclosure of legal actions pertaining to a prior business “of the seller,” and so including the seller's key personnel in the definition of “prior business” is confusing. Second, § 437.3(a)(3)(i)(C) separately requires disclosure of legal actions pertaining to the seller's key personnel, namely, “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.” The change, therefore, does not affect the scope of the required disclosure of legal actions, but rather clarifies a term that is otherwise confusing and somewhat redundant. Accordingly, the Commission adopts the definition of “prior business” with the modification recommended by the staff.

211

Proposed § 437.1(k) of the RPBOR would have defined “prior business” to mean:

(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.

212

Id.

13. Section 437.1(m): Providing Locations, Outlets, Accounts, or Customers

The definition of “providing locations, outlets, accounts, or customers” relates to the third prong of the “business opportunity” definition, which sets forth the types of assistance the seller represents it will provide to the purchasers of its business opportunity.

213

The Commission's law enforcement history shows that fraudulent business opportunity sellers

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