| Comment #82 INTERNATIONAL FRANCHISE ASSOCIATION World Headquarters: 1350 New York Avenue. N.W. Suite 900 Washington. D.C. 20005-4709 May 16, 1997 Mr. Donald S. Clark RE: 16 CFR Part 436 Dear Mr. Clark: The International Franchise Association'(IFA") is pleased to submit these comments in response to the Federal Trade Commission's ("FTC") request for comments contained in its Advance Notice of Proposed Rulemaking ("ANPR") regarding the trade regulations rule entitled "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures"("FTC Rule"). IFA responded to the FTC's prior request for comments in 1995 and will not repeat those earlier comments. IFA has selected certain issues referred to in the ANPR which are of general interest to its membership. IFA expects that individual members will address specific concerns with separate letters. IFA also hopes to participate in the public work shop conferences to further elucidate upon its positions and concerns. 1. Modifications to the Franchise Rule Disclosure Requirements. As stated in its earlier letter, IFA supports replacing the FTC Rule disclosure format with theUniform Franchise Offering Circular format ("UFOC"). However, the three-year phase-in of audited financial statements should be preserved from the FTC Rule format. This phase-in is helpful because it eliminates one major hurdle for companies new to franchising - the significant cost of audited financial statements. I FA believes that the changes to certain UFOC requirements discussed in the ANPR are, for the most part, unnecessary and objectionable. The litigation disclosures of Item 3 currently are quite broad and inclusive (some would argue over-inclusive). Item 3 now requires disclosure of a broad range of claims against a franchisor, including counterclaims or cross-claims asserted by a defendant-franchisee in litigation brought by a franchisor. This should be enough for a prospective franchisee to evaluate whether such litigation will impact his/her investment decision. Disclosure of litigation brought by a franchisor proves nothing; a prospect probably would not place a great value on such information unless the defendant filed a counter claim against the franchisor. IFA members rarely file litigation without taking into consideration the fact that counterclaims almost certainly will be asserted. IFA is unaware of any reported instances of franchisors filing numerous complaints against franchisees in bad faith or for some other tactical advantage. With respect to Item 20, IFA is concerned about certain statistical overlap in counting franchisee turnover. There is no good rationale for the"double-counting" that is referred to in the UFOC. As the FTC is aware, the NASAA Franchise Committee is now working to resolve these issues so that FTC action may be unnecessary. However, IFA believes that the FTC should support the correction of these statistical deficiencies and urge NASAA to make the necessary changes. Finally, IFA is unaware of any broad usage of "gag orders" by franchisors. As the FTC is aware, a gag order would be ineffectual in the context of litigation required to be disclosed in Item 3. There may be instances where a franchisor and a franchisee settle a dispute before litigation and agree to keep the resolution confidential. This may occur as a result of mediation, peer review or some other informal dispute resolution mechanism. The confidentiality of those processes is often the key to their effectiveness. To now require public disclosure of the parties resolution of their dispute would discourage use of such ADR mechanisms. lnaddition, IFA is unaware of any evidence that franchisors are prohibiting current and former franchisees from talking to prospective franchisees. This would impede the entire sales process by cutting off access to some of the franchisors most vocal advocates, its franchisees. Some franchisees choose not to speak to prospects but [FA doubts that such is the result of franchisor-imposed gag orders. 2. Distinguishing Between Disclosure Requirements for Business Opportunities and for Franchises. IFA continues to support the proposition that business opportunities be separated from franchises for regulatory and disclosure purposes. Franchising has been unfairly tainted by its association with business opportunities in the FTC Rule. IFA suggests, however, that the proposed definition of a business opportunity in the ANPR is far too broad. It would capture dealerships, distributorships, sales representatives, licenses and even the sale of an independent business by its owner to a third party. lf a new definition is sought, state business opportunity laws present a number of alternatives. In any event, a lengthy list of exemptions and inclusions will be necessary, including franchises and the types of businesses described above. 3. Conditional Exemption for Trade Show Promoters I FA believes that, at a minimum, the FTC should retain the conditional exemption for trade show promoters. Trade show promoters do not act as "brokers," nor do show promoters have incentive to mislead consumers since, as a practical matter, show promoters are not involved in the offer and sale of franchises at trade shows. Since trade show promoters lack the resources necessary to effectively monitor the practices of each exhibitor at a trade show, extending such liability to show promoters would have a chilling effect on promoters, reducing the number of shows to the detriment of both franchisors and franchisees. 4. Earnings Disclosures. IFA endorses the FTC's position in the ANPR that earnings claims should not be made mandatory at this time. Current trends indicate that increasing numbers of franchisors are making earnings claims. Market forces will incentivize franchisors to provide such disclosures. (If a competitor is doing so, a franchiser may be "forced" to prepare an earnings claim disclosure in order to effectively sell franchises). IFA believes that the FTC is in a unique position to "prompt" franchisors to voluntarily make earnings disclosures and to rely on market-based solutions to create an environment in which franchisors will make such disclosures. When the FTC determines its final position on earnings disclosures, IFA urges coordination and cooperation with NASAA. If a franchisor is faced with two distinct regulatory regimes on earnings claims, it is likely that compliance errors and confusion will result. A franchisor will have to use two materially differentUFOCs depending on the state, and prospective franchisees in certain states will not receive the same information as those in other states. If a state approves an earnings claim (mandated by the UFOC) but the FTC believes the information is unreliable, will the FTC override the state approval and file an enforcement action? Should a franchiser bear the brunt of such an action after receiving another regulator's stamp of approval? In addition to the obvious needs for federal and state consistency, IFA also believes that the FTC should recognize the diversity of industries involved in franchising. This diversity strongly suggests the inappropriateness of "cookie-cutter" solutions to earnings claim issues. The FTC's final position on this matter should emphasize the need for regulatory flexibility in dealing with franchise earnings claims. 5. New Marketing Practices and Technological Developments. The FTC should finally and clearly state that the FTC Rule does not apply to international transactions. The need for certainty is clear from the recent decision in Nieman v. Dryclean U.S.A. Franchise Company, Inc. In this case, a federal court held that the FTC Rule, through the Florida "little FTC Act," applied to the sale of a franchise for Argentina. The erroneous and unjustifiable result in this case indicates that the FTC's informal policies should be reduced to writing in the FTC Rule itself. IFA proposes that the language of the FTC Rule and the Interpretive Guides specifically state that a disclosure document must be used only for the offer and sale of franchises in the U.S. This statement should also indicate that this is a clarification and reiteration of the FTC's position that the disclosure requirements do not apply to international transactions. Obviously, the latter statement is crucial to insure that existing international agreements are retroactively exempted from the FTC Rule. This is not intended to eliminate the FTC's right to challenge fraudulent behavior, but the FTC Rule disclosure mandate should be limited to U.S. franchise locations. IFA's general counsel is preparing separate comments on the "co-branding" issue. IFA believes that the current regulatory scheme already provides an appropriate framework for disclosures applicable to co-branded arrangements. However, it may be useful to expand certain exclusions and exemptions (e.g., fractional franchise) to facilitate the growth of co-branding. IFA counsel's letter covers this issue in detail. Finally, IFA strongly supports the continuation of the "first personal meeting" rule. This rule is far superiorto the "first substantive discussiory" standard described in the ANPR. Franchisors now have relatively clear guidance as to when a UFOC must be delivered. Even if the parties never meet in person, the "ten business day" rule insures that prospective franchisees have more than adequate time to considertheir investment decision. When does the "first substantive discussior" occur? Must a franchisor stop a telephone discussion with a prospect after five minutes and forego further conversation until the UFOC is delivered? Must a UFOC always be sent with promotional materials? Can a franchisor qualify a candidate before it is required to send a UFOC? Is a franchisor required to include the entire UFOC on its website, including financial information, so that it is available to anyone in the public domain? These are only a few of the issues raised by a change in delivery requirements. IFA believes that such a change would be harmful to franchising and would create compliance nightmares, and IFA is unaware of any systemic deficiencies in the current requirements that warrant such a change. 6. Alternatives to Burdensome Regulations and Enforcement The IFA applauds the FTC and the Administration for making regulatory reform a top priority and for taking steps to reduce regulatory burdens, where appropriate, on the private sector. IFA believes that effective regulatory reform can best be achieved through public-private initiatives, and that in order to make most effective use of its limited resources, the FTC should consider alternatives including expanded educational initiatives and industry self-regulation. I FA is in a unique position to assist the FTC in achieving these goals, and has made considerable progress in both areas during the past few years. IFA educational programs, seminars and conferences, coupled with the distribution of franchising information through the sales of publications and other informational materials, annually educate thousands of individuals interested in franchising. In addition, IFA recently adopted a revised and strengthened Code of Principles and Standards of Conduct to which its members must adhere. The Code proscribes a certain minimum level of business standards which must be applied to the franchisor-franchisee relationship. IFA also now has a vibrant franchisee membership which includes franchisee representation at the Executive Committee and Board of Directors levels and every standing commiffee of the association. Finally, the IFA has embraced the National Franchise Mediation Program and other similar programs designed to encourage nonlitigated dispute resolution between franchisees and franchisors. IFA recognizes the limited resources available to the Commission to pursue minor and technical violations of the Rule and believes that the Commission should properly allocate its resources to pursue material violations of the Rule which cause significant consumer injury. For this reason, IFA would support a program to reduce or waive civil penalties for technical and minor violations of the FTC Rule. If a franchisor violates the FTC Rule on an isolated basis (e.g., it misses the ten-business day delivery rule by a few days), the violation has not caused widespread consumer injury and should be waived and no penalty incurred. If there are several minor violations, it may be appropriate to notify the franchiser and ask for an assurance of discontinuance of the violations. (This method is already used in certain states). IFA believes that joint public-private initiatives to conduct education and notification have the potential to assist the FTC in its goal of achieving the highest possible levels of Rule compliance while simultaneously limiting the regulatory burden on franchise systems. IFA would be pleased to discuss this process further at the public workshops, and would be prepared to continue and expand its educational programs on disclosure compliance. IFA looks forward to working with the FTC to improve the FTC Rule. If any additional information is needed, IFA would be pleased to provide its assistance. Sincerely, Matthew R. Shay |