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

FEDERAL TRADE COMMISSION

16 CFR Part 436

Request for Comments Concerning Trade Regulation Rule on

Disclosure Requirements and Prohibitions Concerning Franchising and

Business Opportunity Ventures

AGENCY: Federal Trade Commission.

ACTION: Request for public comments.

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SUMMARY: The Federal Trade Commission (the ``Commission'') is

requesting public comments on its Trade Regulation Rule on Disclosure

Requirements and Prohibitions Concerning Franchising and Business

Opportunity Ventures (``the Franchise Rule'' or ``the Rule''). The

Commission is requesting comments about the overall costs and benefits

of the Rule and its overall regulatory and economic impact as a part of

its systematic review of all current Commission regulations and guides.

The Commission also is requesting comment on whether the Rule should be

modified to: Replace the Rule's disclosure requirements with those set

forth in the revised Uniform Franchise Offering Circular Guidelines,

approved by the Commission on December 30, 1993; modify the scope of

disclosure requirements for business opportunity ventures; clarify the

applicability of the Rule to trade show promoters; and require the

disclosure of earnings information. All interested persons are hereby

given notice of the opportunity to submit written data, views, and

arguments concerning the Rule.

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

ADDRESSES: Comments should be directed to: Secretary, Federal Trade

Commission, Room H-159, Sixth and Pennsylvania Ave., NW., Washington,

DC 20580. Comments about the Franchise Rule should be identified as

``16 CFR Part 436--Comment.''

Notification of interest in the Public Workshop-Conference should

be submitted in writing to Myra Howard, Division of Marketing

Practices, Federal Trade Commission, Washington, DC 20580.

FOR FURTHER INFORMATION CONTACT: Steven Toporoff, (202) 326-3135, or

Myra Howard, (202) 326-2047, Division of Marketing Practices, Bureau of

Consumer Protection, Federal Trade Commission, Washington, DC 20580.

SUPPLEMENTARY INFORMATION: The Commission has determined, as part of

its oversight responsibilities, to review Rules and guides

periodically. These reviews seek information about the costs and

benefits of the Commission's Rules and guides and their regulatory and

economic impact. The information obtained assists the Commission in

identifying Rules and guides that warrant modification or rescission.

The Commission is currently seeking comment on several issues

specific to the Franchise Rule. The Commission recognizes that there

have been changes in the franchise industry since the Rule was

promulgated in 1978. Among these changes is the modification of the

Uniform Franchise Offering Circular (``UFOC'') Guidelines by the North

American Securities Administrators Association (``NASAA''). In 1986,

NASAA revised Item 19 of the Guidelines to require franchisors who make

earnings claims to have a reasonable basis for such claims. On April

25, 1993, NASAA revised the entire UFOC Guidelines. The Commission

approved the revised UFOC Guidelines on December 30, 1993. The

Commission now seeks comment on the desirability of replacing the

current Rule disclosure requirements with those set forth in the

revised UFOC Guidelines. The Commission also seeks comment on the

desirability of modifying the scope of the Rule as it pertains to the

sale of business opportunities. In addition, the Commission seeks

comment on whether it should revoke the current conditional exemption

for trade show promoters and whether it should modify the Rule to add

specific disclosure requirements or prohibitions concerning trade show

promoters. Finally, there has been considerable discussion in the

franchise industry and among franchise regulators about requiring the

disclosure of earnings information to prospective investors. The

Commission solicits comment on the desirability of modifying the Rule

to require the disclosure of earnings information, and if so, what form

those disclosures should take.

A. Background

The Franchise Rule was promulgated by the Commission on December

21, 1978. 43 Fed. Reg. 59,614. The Rule makes it an unfair or deceptive

act or practice for franchisors and franchise brokers to fail to

disclose to prospective franchisees specific information about the

franchisor, franchise business, and terms of the franchise agreement.

Franchisors and franchise brokers must disclose additional information

if they make any claim about actual or potential earnings to

prospective franchisees or to the media. The Rule sets forth both the

form and content of the required disclosures. Franchisors must provide

prospective franchisees with the required disclosures before any sale

is made.

B. Issues for Comment

1. The Revised UFOC

The Franchise Rule sets forth the content and form of the required

disclosures. 16 CFR 436.1(a)-(e). In lieu of the Rule's format, the

Commission has accepted the UFOC Guidelines originally adopted by the

Midwest Securities Commissioners Association on September 5, 1975. 44

FR 49,966, 49,970, and as subsequently amended by NASAA on November 27,

1986. 52 FR 22,686. Most recently, NASAA petitioned the Commission to

approve new amendments to the UFOC Guidelines, which NASAA adopted on

April 25, 1993. See Extra Edition, Bus. Fran. Guide (CCH), Rpt. No. 161

(May 25, 1993). The Commission approved the use of the new UFOC on

December 30, 1993. 58 FR 69,224. The new amendments are the product of

a comprehensive revision of the UFOC Guidelines. The Commission is

concerned about costs and other potential disadvantages to franchisors

and franchisees that may result from a lack of uniformity between

federal and state regulations. Accordingly, the Commission solicits

comments on whether it is desirable to revise the Rule by replacing the

current Rule disclosure requirements with those set forth in the

revised UFOC Guidelines.

2. The Application of the Franchise Rule to Business Opportunities

The Franchise Rule applies to both franchises and business

opportunities. The Rule currently does not provide a specific

definition of the term ``business opportunity.'' Rather, the Rule's

definition of the term ``franchise'' includes some forms of business

opportunities. Specifically, if the following three conditions are met,

a business opportunity will be deemed a franchise:

(A) A person (hereinafter ``franchisee'') offers, sells, or

distributes to any person other than a ``franchisor'' (as hereinafter

defined), goods, commodities, or services which are: [[Page 17657]]

(1) Supplied by another person (hereinafter ``franchisor''), or

(2) Supplied by a third person (e.g., a supplier) with whom the

franchisee is directly or indirectly required to do business by another

person (hereinafter ``franchisor''); or

(3) Supplied by a third person (e.g., a supplier) with whom the

franchisee is directly or indirectly advised to do business by another

person (hereinafter ``franchisor'') where such third person is

affiliated with the franchisor; and

(B) The franchisor:

(1) Secures for the franchisee retail outlets or accounts for said

goods, commodities, or services; or

(2) Secures for the franchisee locations or sites for vending

machines, rack displays, or any other product sales display used by the

franchisee in the offering, sale, or distribution of said goods,

commodities, or services; or

(3) Provides to the franchisee the services of a person able to

secure the retail outlets, accounts, sites or locations * * *; and

(C) The franchisee is required as a condition of obtaining or

commencing the franchise operation to make a payment or a commitment to

pay [at least $500 within the first six months of operation] to the

franchisor, or to a person affiliated with the franchisor.

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

Accordingly, the Commission seeks comment on the desirability of

modifying the Rule to include a specific definition of the term

``business opportunity.'' The Commission also seeks comment on whether

such a definition should include other business opportunity formats

that are currently not covered by the Rule, such as multi-level

marketing, seller assisted market plans, work-at-home plans, and

certain distributorships and licenses.

The Commission is also concerned that the Rule's disclosure

requirements may not be well suited to the sale of business

opportunities and may impose unnecessary costs on both business

opportunity sellers and buyers. Accordingly, the Commission seeks

comment on whether to modify the Rule to require different disclosures

for the sale of business opportunities. Specifically, the Commission

seeks comment on what disclosures are most relevant to business

opportunity purchasers. The Commission asks whether certain Rule

disclosures should be eliminated and if any additional disclosures

should be required.

3. Trade Show Promoter Liability

The Franchise Rule applies to franchisors and franchise brokers.

Franchise brokers are jointly and severally liable for violations of

the Franchise Rule. 16 CFR 436.1, 436.2(j). In 1981, the Commission

advised trade show promoters that they would be exempt from Rule

coverage as brokers if they provided trade show attendees with a

specific consumer education notice. The notice advises consumers that

the Commission's Franchise Rule grants them rights to receive certain

information about a franchise investment prior to signing agreements.

See 46 FR 52327 (October 27, 1981). The exemption requires trade show

promoters to give trade show attendees the required notice upon their

first entry to the show. Trade show promoters who fail to distribute

the required consumer education notice may be held jointly and

severally liable for all participating franchisors' Rule violations

that may occur at the shows.

Since the Commission issued this conditional exemption in 1981, the

sale of franchises and business opportunities at trade shows has

increased significantly. In 1994, the Commission settled charges of

Rule violations against two trade show promoters who allegedly failed

to provide the required consumer education notices at their respective

shows. The Commission solicits comments on the desirability of revoking

the conditional exemption for trade show promoters. In addition, the

Commission seeks comment on whether the Rule should be revised to

provide separate disclosure requirements and prohibitions for trade

show promoters.

4. Earnings Disclosure Requirements

Franchisors making claims about actual or potential sales, profits,

or earnings must provide detailed disclosures mandated by

Sec. 436.1(b)-(e) of the Rule. Section 436.1(b) enumerates the

substantiation requirements for claims based on projections or

forecasts; Sec. 436.1(c), for claims based on actual operating results;

and Sec. 436.1(e), for claims that appear in media advertising. The

franchisor must have a ``reasonable basis'' for all such claims; they

must be ``geographically relevant'' to the potential franchisee's

market area; and, if they are based on operating results, must be

prepared in accordance with generally accepted accounting principles.

The franchisor must also give a separate earnings claim disclosure

document to any potential investor to whom such a claim is made. The

earnings claim document must contain a cover page specified by

Sec. 436.1(d); a full statement of the basis and assumptions for the

claim; prescribed cautionary language; a notice that substantiating

material is available for inspection by investors; a disclosure of the

number and percentage of the franchisor's outlets that have achieved

the same or better results; and various additional information,

depending on the type of claim made.

The Franchise Rule does not mandate the disclosure of actual or

projected earnings information. The NASAA Franchise Committee and some

members of its Industry Advisory Committee, however, have proposed that

franchisors and promoters of business opportunities be required to

disclose and provide substantiation for some form of earnings

information to potential investors. They are concerned that, in the

absence of required earnings disclosures, prospective investors seeking

information about potential earnings may receive unsubstantiated,

misleading, deceptive, and possibly false earnings information. The

Commission shares this concern. Over the past five years, allegations

of false and deceptive earnings claims have been the most common

allegation set forth in Commission complaints filed against franchisors

and business opportunity promoters. Therefore, the Commission seeks

comments on the desirability of modifying the Rule to include a

mandatory earnings disclosure. In particular, the Commission seeks

comments on the specific benefits of such disclosures to prospective

investors as well as the potential for mandated earnings disclosures to

mislead prospective investors. In addition, the Commission requests

comment on potential burdens and compliance costs that such Rule

modification might impose on prospective franchisees and franchisors.

The Commission specifically requests commentors to submit statistical

information, including survey data, or other report materials, in

support of their comments.

C. Request for Comment

At this time, the Commission solicits written public comments on

the following questions:

(1) Is there a continuing need for the Rule?

(a) To what extent do franchisors use the Commission's Franchise

Rule format?

(b) What benefits has the Rule provided to purchasers of franchises

and business opportunities?

(c) Has the Rule imposed costs on purchasers? Explain.

(2) What changes, if any, should be made to the Rule to increase

the benefit of the Rule to purchasers? [[Page 17658]]

(a) How would these changes affect the costs the Rule imposes on

firms subject to its requirements?

(3) What significant burdens or costs has the Rule imposed on firms

subject to its requirements?

(a) Has the Rule provided benefits to such firms? Explain.

(4) What changes, if any, should be made to the Rule to reduce the

burdens or costs imposed on firms subject to its requirements?

(a) How would these changes affect the benefits provided by the

Rule?

(5) Does the Rule overlap or conflict with other Federal, state, or

local laws or regulations?

(6) Since the Rule was issued, what effects, if any, have changes

in relevant technology, economic conditions, and industry practices had

on the Rule?

The Revised UFOC Guidelines

(7) Would it be in the public interest for the Commission to

establish one national franchise disclosure standard?

(8) Should the Commission revise the Rule by replacing the Rule's

required disclosures with those set forth in the revised UFOC

Guidelines, approved by the Commission on December 31, 1993? Explain.

(a) What would be the costs and benefits of such a revised Rule on

sellers of franchises and business opportunities?

(b) What would be the costs and benefits of such a revised Rule on

purchasers of franchises and business opportunities?

The Applicability of the Rule to Business Opportunities

(9) To what extent do business opportunity sellers currently comply

with the Rule?

(10) What are the costs and benefits of the Rule to business

opportunity sellers subject to the Rule's disclosure requirements?

(11) What are the costs and benefits of the Rule to prospective

purchasers of business opportunities?

(12) To what extent do purchasers of business opportunities obtain

relevant and material information from the required disclosures?

Explain.

(13) Should the Commission clarify the Rule by adding a separate

definition of the term ``business opportunity?'' Explain.

(a) Should such a definition of ``business opportunity'' be

expanded beyond the current definition of a ``business opportunity''

franchise? Explain.

(b) Should such a definition include the sale of other business

arrangements such as multi-level marketing, seller assisted marketing

plans, work-at-home plans, and certain distributorships and licenses?

Explain.

(14) Should the Commission revise the Rule's disclosure

requirements for sellers of business opportunities? Explain.

(a) Should the Commission require a different disclosure document

for business opportunities?

(b) What information do purchasers of business opportunities need

that is not currently required by the Rule?

(c) What disclosures currently required by the Rule should be

eliminated?

(15) What would be the costs and benefits to firms that would be

subject to such revised disclosure requirements?

(16) What would be the costs and benefits of such revised

disclosure requirements to purchasers of business opportunities?

Trade Show Promoter Liability

(17) Should the Commission revoke the current conditional exemption

to the Rule for trade show promoters? Explain.

(a) To what extent do consumers purchase franchises or business

opportunities as a result of attending franchise trade shows?

(b) To what extent do exhibitors at trade shows violate the Rule in

their presentations to consumers? What is the nature of any such

violations?

(c) What would be the costs and benefits of revoking the

conditional exemption to the Rule?

(18) Should the Commission revise the Rule to include separate

disclosures and prohibitions for trade show promoters? Explain.

(a) What disclosures should trade show promoters be required to

make to show attendees?

(b) What conduct should the Rule prohibit trade show promoters from

engaging in?

(c) What would be the costs and benefits of such a revised Rule?

Earnings Information

Background

(19) To what extent do prospective franchisees want information

about (a) actual earnings and (b) projected earnings?

(20) To what extent do prospective franchisees receive pre-sale

written or oral earnings information?

(a) To what extent do franchisees receive historical earnings

information?

(b) To what extent do franchisees receive earnings projections or

other earnings claims?

(c) To what extent do franchisees receive substantiation for such

earnings information or earnings projections?

(21) To what extent do franchisors currently provide earnings

disclosures to prospective franchisees?

(a) To what extent do franchisors provide historical earnings

information?

(b) To what extent do franchisors provide earnings projections or

other earnings claims?

(c) To what extent do franchisors substantiate such earnings

information or earnings projections?

(22) For those franchisors that do provide earnings information:

(a) In what industries are these franchisors engaged?

(b) What is their size (e.g., number of franchisees and gross

revenues of the franchise system)?

(c) Does the franchisor use the UFOC or FTC disclosure document

format?

(23) To what extent do (a) the Rule requirements and (b) the UFOC

requirements inhibit franchisors from providing historical earnings

information or earnings projections to prospective franchisees?

Explain.

(24) In the absence of earnings disclosures under the Rule or UFOC,

is earnings information available to prospective franchisees from other

sources? Explain.

(a) What are the costs to prospective franchisees to obtain such

information?

(b) To what extent is such information accurate and reliable?

Financial Data Currently Available to Franchisors

(25) To what extent do franchisors routinely receive financial and/

or other operating performance information from franchisees?

(a) What types of information do franchisors receive?

(b) Do franchisees give the information voluntarily or by

contractual requirements?

(c) How often do franchisors receive such information?

(d) How long is such information retained by franchisors?

(26) Are the financial data currently submitted by franchisees

sufficient to enable franchisors to provide prospective franchisees

with an accurate appraisal of the financial risks of investing in a

franchise? Explain.

(a) If the data are insufficient to provide such information, what

additional information would correct the deficiency?

(b) What would be the additional costs and benefits of obtaining

and providing this additional information to prospective franchisees?

[[Page 17659]]

(27) To what extent do franchisors conduct periodic audits of

franchisee financial operations? Explain.

(28) To what extent do franchisors require franchisees to use

particular accounting formats? Explain.

Possible Required Earnings Disclosures

(29) Would it be in the public interest for the Commission to

establish one national earnings claims disclosure requirement? Explain.

(30) What types of earnings data, or other measures of franchisee

operating performance, would be most useful to prospective franchisees

(e.g., revenues, royalties, net income before income taxes, break-even

sales volume, time to reach a break-even point, return on investment)?

Describe.

(31) Are there industries for which traditional financial measures

of operating performance are either irrelevant or inadequate to provide

prospective franchisees with useful earnings information?

(a) What are these industries?

(b) What supplemental information could these industry franchisors

provide to ensure that prospective franchisees receive useful earnings

information?

(32) Should the Rule be revised to require franchisors to disclose

information about franchisee success rates? If so, which measure of

success (e.g., failures, turnover, or longevity in a franchise system)

would most help franchisees gauge the financial success of the system?

Explain.

(a) How should a franchisee failure be defined? Explain.

(b) What type of franchisee failure data (number of failures,

failure rates, or longevity of franchisees who fail) would be most

useful to prospective franchisees?

(c) How should franchisee turnover be defined? Explain.

(d) What type of franchisee turnover data (number of failures,

terminations, cancellations, or transfers) would be most useful to

prospective franchisees?

(e) Should information about franchisee longevity in a franchise

system, regardless of reasons for departure, be disclosed to

prospective franchisees? Explain.

(f) What are the costs and benefits of requiring franchisors to

disclose information about franchisee failures, turnover, or longevity

in a franchise system?

(33) Is it possible to have a uniform earnings disclosure

requirement for all franchise systems? Explain.

(34) How can an earnings disclosure requirement be configured to

assure relevancy to the market location being considered? What types of

earnings information would be relevant? Explain.

(35) How can an earnings disclosure requirement be configured to

reflect differences in the length of franchisees' operating experience?

Explain.

(36) How frequently should earnings disclosures be updated?

(37) How long should prospective franchisees be given to review

required earnings disclosures before signing a contract? Is the Rule's

ten-day minimum review period sufficient? Explain.

(38) If the Commission requires earnings disclosures, should

franchisors be prohibited from making earnings disclosures other than

those mandated by the revised Rule? Explain.

(39) In what ways might a mandatory earnings disclosure be

misleading or deceptive to prospective franchisees? Explain the

specific form of earnings disclosure (e.g., gross sales, profit and

loss statements, average net income) and why it may be misleading or

deceptive.

Possible Exemptions and Special Circumstances

(40) What kind of meaningful earnings information can new franchise

systems provide to prospective franchisees? Explain.

(a) Should a new franchise system be exempt from an earnings

disclosure requirement?

(b) What would be an appropriate exemption period?

(c) Should a new franchisor be required to provide a negative

disclosure cautioning prospective franchisees that its franchise system

has not been in business long enough to provide an accurate earnings

history?

(41) What kind of meaningful earnings information can a small

franchise system provide to prospective franchisees? Explain.

(a) How should the term ``small franchise system'' be defined?

(b) Would compliance with an earnings disclosure requirement impose

significant burdens and costs on small franchise systems?

(c) Should a small franchise system be exempt from an earnings

disclosure requirement? If so, should a qualifying small franchise

system be required to provide a negative disclosure cautioning

prospective franchisees that its franchise system cannot provide

accurate and reliable earnings information?

(42) Should the Commission consider exemptions to an earnings

disclosure requirement for other circumstances? Explain.

Additional Considerations

(43) What concerns do franchisors have about being required to

provide earnings information to prospective franchise purchasers? How

can the Commission address these concerns?

(44) If the Commission adopts a mandatory earnings disclosure

requirement, franchisors might be compelled to collect financial data

from franchisees. What concerns do franchisees have about: (a)

revealing financial data to their franchisors; and (b) franchisors' use

of their financial data to comply with an earnings disclosure

requirement? How can the Commission address these concerns?

(45) To what extent do franchisors' contractual agreements with

franchisees prevent franchisees from disclosing information about their

own operating performance to prospective franchisees? How should the

Commission address this concern?

D. Invitation to Comment

In reviewing the Franchise Rule, Commission staff will consider all

comments submitted by August 11, 1995. Comments submitted will be

available for public inspection in accordance with the Freedom of

Information Act (5 U.S.C. 552) and Commission regulations, on normal

business days between the hours of 8:30 a.m. and 5 p.m. at the Public

Reference Section, Room 130, Federal Trade Commission, 6th Street and

Pennsylvania Avenue, N.W., Washington, D.C. 20580.

E. Public Workshop Conference

The FTC staff will conduct a Public Workshop Conference to discuss

written comments received in response to this Request for Comments. The

purpose of the conference is to afford Commission staff and interested

parties a further opportunity to openly discuss and explore issues

raised during the rule review, and, in particular, to examine publicly

any areas of significant controversy or divergent opinions that are

raised in the written comments. Commission staff will consider the

views and suggestions made during the conference, in conjunction with

the written comments, in formulating its final recommendation to the

Commission concerning the review of the Franchise Rule.

Commission staff will select a limited number of parties, from

among those who submit written comments, to represent the significant

interests affected by the Rule Review. These parties will participate

in an open discussion of the issues. It is contemplated that the

selected parties might ask and answer questions based on their

respective comments.

In addition, the conference will be open to the general public.

Members of [[Page 17660]] the general public who attend the conference

may have an opportunity to make a brief oral statement presenting their

views on issues raised in the Rule Review. Oral statements of views by

members of the general public will be limited to a few minutes in

length. The time allotted for these statements will be determined on

the basis of the time allotted for discussion of the issues by the

selected parties, as well as by the number of persons who wish to make

statements.

Written submissions of views, or any other written or visual

materials, will not be accepted during the conference. The discussion

will be transcribed and the transcription placed on the public record.

The conference will be held in the early fall over the course of

two consecutive days. A forthcoming announcement will provide the exact

dates and location. Parties interested in participating must notify

Commission staff by August 11, 1995.

List of Subjects in 16 CFR Part 436

Advertising, Business and industry, Franchising, Trade practices.

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

By direction of the Commission.

Donald S. Clark,

Secretary.

[FR Doc. 95-8619 Filed 4-6-95; 8:45 am]

BILLING CODE 6750-01-P