IT IS TIME FOR THE FEDERAL TRADE COMMISSION TO REQUIRE FINANCIAL PERFORMANCE REPRESENTATIONS TO PROSPECTIVE FRANCHISEES

11 Wake Forest J. Bus. & Intell. Prop. L. 55

As our country moves beyond the recent years of financial and investment abuses fueled by greed and corruption—such as the Enron accounting scandal, Bernie Madoff and other Ponzi schemes, and the subprime mortgage housing crisis—the need for greater regulation and effective enforcement, as well as transparency in the financial community, have become vital issues. Burned by huge financial losses, the public clamors for reforms that will eliminate or at least mitigate similar calamities in the future. Although the country and Congress have their eyes glued on the banking industry and the investment sector, another popular and very pervasive business system begs reexamination in terms of appropriate governmental regulation. This is the ever-growing arena of franchising.

Notwithstanding the significance this business system has on the U.S. economy and on the lives of U.S. citizens, there continue to be serious gaps in the regulation of the sale of franchises to prospective franchisees by the Federal Trade Commission. These gaps have created opportunities for serious financial abuse, have helped perpetuate ongoing fraudulent schemes, bad investments and hidden agendas, and have fostered serious misrepresentations about the viability of new franchised businesses, thereby causing significant injury to investors purchasing start-up franchises.

Although the FTC’s Franchise Rule requires pre-sale disclosure by franchisors to prospective franchisees of certain material information to assist the prospect in making an informed investment decision, surprisingly, the FTC fails to require the person selling the franchise (“franchisor”) to answer the most pertinent question that any prospective buyer of the franchise (“franchisee”) should ask, that is: “How much money can I reasonably expect to make operating the franchise, based on the experiences of the existing franchisees?”

Although such a disclosure is of paramount interest to a prospective franchisee, the FTC, through Item 19 of the Franchise Disclosure Document (“FDD”), does not mandate such disclosure but rather merely makes disclosure of this information optional. For the improved health of the franchise industry—by rewarding profitable franchise concepts and weeding out the unprofitable ones—as well as the financial well-being of franchisees, it is imperative that the FTC correct this problem by making Financial Performance Representations (“FPRs”) a mandatory pre-sale disclosure requirement.