```

[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]

 
  THE FTC'S FRANCHISE RULE: TWENTY-THREE YEARS AFTER THE PROMULGATION
=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                COMMERCE, TRADE, AND CONSUMER PROTECTION

                                 of the

                    COMMITTEE ON ENERGY AND COMMERCE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             JUNE 25, 2002

                               __________

                           Serial No. 107-116

                               __________

      Printed for the use of the Committee on Energy and Commerce

 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 house

                       U. S. GOVERNMENT PRINTING OFFICE
80-679                          WASHINGTON : 2002
___________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512-1800  
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001

                               __________
                    COMMITTEE ON ENERGY AND COMMERCE

               W.J. ``BILLY'' TAUZIN, Louisiana, Chairman

MICHAEL BILIRAKIS, Florida           JOHN D. DINGELL, Michigan
JOE BARTON, Texas                    HENRY A. WAXMAN, California
FRED UPTON, Michigan                 EDWARD J. MARKEY, Massachusetts
CLIFF STEARNS, Florida               RALPH M. HALL, Texas
PAUL E. GILLMOR, Ohio                RICK BOUCHER, Virginia
JAMES C. GREENWOOD, Pennsylvania     EDOLPHUS TOWNS, New York
CHRISTOPHER COX, California          FRANK PALLONE, Jr., New Jersey
NATHAN DEAL, Georgia                 SHERROD BROWN, Ohio
RICHARD BURR, North Carolina         BART GORDON, Tennessee
ED WHITFIELD, Kentucky               PETER DEUTSCH, Florida
GREG GANSKE, Iowa                    BOBBY L. RUSH, Illinois
CHARLIE NORWOOD, Georgia             ANNA G. ESHOO, California
BARBARA CUBIN, Wyoming               BART STUPAK, Michigan
JOHN SHIMKUS, Illinois               ELIOT L. ENGEL, New York
HEATHER WILSON, New Mexico           TOM SAWYER, Ohio
JOHN B. SHADEGG, Arizona             ALBERT R. WYNN, Maryland
CHARLES ``CHIP'' PICKERING,          GENE GREEN, Texas
Mississippi                          KAREN McCARTHY, Missouri
VITO FOSSELLA, New York              TED STRICKLAND, Ohio
ROY BLUNT, Missouri                  DIANA DeGETTE, Colorado
TOM DAVIS, Virginia                  THOMAS M. BARRETT, Wisconsin
ED BRYANT, Tennessee                 BILL LUTHER, Minnesota
ROBERT L. EHRLICH, Jr., Maryland     LOIS CAPPS, California
STEVE BUYER, Indiana                 MICHAEL F. DOYLE, Pennsylvania
GEORGE RADANOVICH, California        CHRISTOPHER JOHN, Louisiana
CHARLES F. BASS, New Hampshire       JANE HARMAN, California
JOSEPH R. PITTS, Pennsylvania
MARY BONO, California
GREG WALDEN, Oregon
LEE TERRY, Nebraska
ERNIE FLETCHER, Kentucky

                  David V. Marventano, Staff Director

                   James D. Barnette, General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

        Subcommittee on Commerce, Trade, and Consumer Protection

                    CLIFF STEARNS, Florida, Chairman

FRED UPTON, Michigan                 EDOLPHUS TOWNS, New York
NATHAN DEAL, Georgia                 DIANA DeGETTE, Colorado
  Vice Chairman                      LOIS CAPPS, California
ED WHITFIELD, Kentucky               MICHAEL F. DOYLE, Pennsylvania
BARBARA CUBIN, Wyoming               CHRISTOPHER JOHN, Louisiana
JOHN SHIMKUS, Illinois               JANE HARMAN, California
JOHN B. SHADEGG, Arizona             HENRY A. WAXMAN, California
ED BRYANT, Tennessee                 EDWARD J. MARKEY, Massachusetts
GEORGE RADANOVICH, California        BART GORDON, Tennessee
CHARLES F. BASS, New Hampshire       PETER DEUTSCH, Florida
JOSEPH R. PITTS, Pennsylvania        BOBBY L. RUSH, Illinois
MARY BONO, California                ANNA G. ESHOO, California
GREG WALDEN, Oregon                  JOHN D. DINGELL, Michigan,
LEE TERRY, Nebraska                    (Ex Officio)
ERNIE FLETCHER, Kentucky
W.J. ``BILLY'' TAUZIN, Louisiana
  (Ex Officio)

                                  (ii)

                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Beales, J. Howard, III, Director, Bureau of Consumer 
      Protection, Federal Trade Commission.......................     6
    Cantone, Dale E., Assistant Attorney General, Maryland 
      Securities Division........................................    22
    Kezios, Susan P., President, American Franchise Association..    32
    Rizer, Jerry, President, Dairy Queen Operators' Association..    42
    Wharton, Phillip Leslie, Vice President, Legal Affairs, 
      Franchise/License Division, Spherion.......................    28
    Wieczorek, Dennis E., Partner, Piper Rudnick, on behalf of 
      The International Franchise Association....................    36

                                 (iii)

  

  THE FTC'S FRANCHISE RULE: TWENTY-THREE YEARS AFTER THE PROMULGATION

                              ----------                              

                         TUESDAY, JUNE 25, 2002

              House of Representatives,    
              Committee on Energy and Commerce,    
                       Subcommittee on Commerce, Trade,    
                                   and Consumer Protection,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10 a.m., in 
room 2322, Rayburn House Office Building, Hon. Cliff Stearns 
(chairman) presiding.
    Members present: Representatives Stearns, Shimkus, Walden, 
and Rush.
    Staff present: Ramsen Betfarhad, majority counsel; Brendan 
Williams, legislative clerk; and Jonathan J. Cordone, minority 
counsel.
    Mr. Stearns. Good morning, everybody. I am pleased to 
welcome all of you to the Commerce, Trade, and Consumer 
Protection Subcommittee hearing on the FTC Franchise Rule. I 
wish to thank the witnesses for appearing before the committee 
and look forward to their testimony.
    The FTC Franchise Rule mandates a pre-sale disclosure of 
certain material facts by a franchisor to a prospective 
franchisee. The rule was promulgated in 1979 and has not 
changed since. A lot can and does change in 23 years. During 
the past 23 years, communism has all but vanished. Global trade 
has expanded exponentially and the Internet has evolved from a 
mere curiosity to an everyday business necessity. Yet the 
Franchise Rule, the rule that regulates one of the fastest 
growing and most important fields of private enterprise, 
franchising, employing more than 8 million Americans and 
accounting for $1 trillion in retail sales, has not changed 
since its inception in 1979.
    As time and circumstances have changed many argue that 
through creative and sometimes not so creative interpretation 
of the 1979 rule, franchisors have avoided disclosing important 
facts and practices to prospective franchisees, creating cause 
for consternation years later when both the franchisee and the 
FTC are powerless to effectively address them. To its credit 
the Commission began the process of reviewing and amending the 
rule in 1997. Nevertheless, the review process has yet to reach 
its fruition and yield a new Franchise Rule more responsive to 
today's business reality.
    Meanwhile, since 1993, 15 States have adopted the Uniform 
Franchisee Offering Circular, UFOC, according greater 
protection to franchisees resident in those States over those 
offered by the Federal rule. The UFOC to a great extent came 
about because many States concluded that the Federal Franchise 
Rule was outdated and therefore less effective.
    Today my colleagues will hear testimony from the Commission 
as to its review efforts and its proposed amendment to the 
rule. We will also hear proposed amendments offered by others, 
most of which share the objective of harmonizing the FTC 
Franchise Rule disclosure requirements with those of the UFOC.
    I commend those efforts. I strongly encourage that the 
Commission undertake its review and amending of the rule on an 
expedited timetable. I also support the promulgation of a 
separate rule for business opportunity franchises, as they pose 
substantially different questions and challenges than business 
format franchises. Amending the rule so that it better serves 
its intended purpose, protection of perspective franchisees 
through pre-sale disclosure of the pertinent facts about the 
franchise is one thing, enforcing the rule is something 
different.
    The Commission reports that since the rules promulgation in 
1979 it has brought over 200 franchise and business opportunity 
cases under both the Rule and Section 5 of the FTC Act. 
Meanwhile, just in the period 1993 to 1999 the Commission 
received nearly 4,000 complaints. The question that I have for 
the Commission is why so few prosecutions?
    Finally, as members we are typically approached by 
aggrieved franchisees, be they friends, constituents, with some 
degree of frequency. Most of the issues that trouble these 
franchisees arise post-sale or after the signing of the 
franchise contract and, as such, don't implicate the disclosure 
requirements of the FTC Franchise Rule. For example, many 
franchisees have complained about the renewal and supply 
sourcing policies, whether the franchisor is required to buy 
all supplies from the franchisor or its designee.
    Now I have had that experience myself having franchises in 
which I have to buy everything from the franchisor, and then 
pretty soon I end up buying the installation by the franchisor. 
Moreover, the franchisees identify encroachment as yet another 
contentious problem. Where a new franchisee was assigned a 
franchise territory they encroached on a preexisting 
franchisee's territory.
    Holiday Inn sells you a franchise. You have a Holiday Inn, 
and pretty soon right next to it goes a Crown Plaza. They are 
upscale, and right next to it goes their budget hotel. And so 
here you thought you had a franchise with Holiday Inn, you find 
you have two competitors side by side, a low end and a high 
end. You go to the book to look where your property is and the 
three properties are there together and you thought you had it.
    Or they give you a franchise and they tell you that there 
will not be a franchise within 5 miles of your property. And lo 
and behold, the rules change and they say, Mr. Stearns, we have 
done a study which shows we are now putting another Howard 
Johnson right within 3 miles of your Howard Johnson. And then I 
say to them, well, that is not fair because you told me I was 
going to have this. And they say, well, our rules changed 
because the population density changes and that means, Mr. 
Stearns, we are putting another Howard Johnson within 3 miles 
of you and there is nothing in the contract that says we can't 
do this. And so, lo and behold, another franchise Howard 
Johnson.
    It might be my friend at Chamber of Commerce, at the 
Kiwanis, who sits with me at lunch who suddenly is my strong 
competitor, and he is a brand new property, I am an older 
property and he is now within 3 miles and, lo and behold, he 
takes my business.
    So I am well aware of some of those things. But these are 
clearly post-sale issues not under our jurisdiction. I can 
complain, can't do anything about it. Nevertheless, I wonder to 
what extent can these post-sale problems be avoided and 
lessened with a better disclosure rule. Some will argue that 
post-sale problems cannot be effectively addressed by any 
disclosure rule. That may be true--still the Commission should 
strive to promulgate a new Franchise Rule that better informs a 
prospective franchisee of some of the challenges such as 
encroachment and renewal that he or she may face post-sale. You 
can't get too much information. The person that comes in should 
be more careful and that is his, the whole caveat emptor as a 
franchisee. You have to assume a certain level of risk. So you 
can't be a cry baby after you sign the contract and say I want 
all these rules changed, because you are a big boy, you are 
putting up your own money and you have to decide if you want to 
go ahead with this.
    If the Federal Franchise Rule is not made more effective, 
more responsive to problems that plague franchisor-franchisee 
relationships today, then the call by some for a Federal law 
governing aspects of post-sale relationship will not subside. 
After all, in the past Congress has enacted post-sale 
relationship statutes applicable to the largest industries 
within the franchising world, the auto and gasoline retailing. 
So we have those exception. We are not suggesting that we do 
that, but we do bring up at this hearing that we have these 
post-sale relationship statutes in place. So we are not 
suggesting it, but I think from the point of information and 
from my colleagues they should realize that these statutes do 
apply to auto and gasoline retailing.
    So that is my opening statement, and with that I am pleased 
to have an opening statement from the ranking member who is 
taking Mr. Towns' place, Mr. Rush.
    [The prepared statement of Hon. Clifford Stearns follows:]
Prepared Statement of Hon. Clifford Stearns, Chairman, Subcommittee on 
                Commerce, Trade, and Consumer Protection
    Good morning. I am pleased to welcome all of you to the Commerce, 
Trade and Consumer Protection subcommittee's hearing on the FTC 
Franchise Rule. I wish to thank the witnesses for appearing before the 
committee and look forward to their testimony.
    The FTC Franchise Rule mandates a pre-sale disclosure of certain 
material facts by a franchisor to a prospective franchisee. The Rule 
was promulgated in 1979 and has not changed since. A lot can and does 
change in 23 years. During the past twenty-three years, communism has 
all but vanished, global trade has expanded exponentially, and the 
internet has evolved from a mere curiosity to an everyday business 
necessity. Yet the Franchise Rule, the rule that regulates one of the 
fastest growing and most important fields of private enterprise 
(franchising) employing more than 8 million Americans and accounting 
for $1 trillion in retail sales, has not changed since its inception in 
1979.
    As the times and circumstances have changed, many argue that 
through creative and sometimes not so creative interpretation of the 
1979 rule, franchisors have avoided disclosing important facts and 
practices to prospective franchisees creating cause for consternation 
years later, when both the franchisee and the FTC are powerless to 
effectively address them. To its credit the Commission began the 
process of reviewing and amending the Rule in 1997. Nevertheless, the 
review process has yet to reach its fruition and yield a new franchise 
rule more responsive to today's business realities. Meanwhile, since 
1993, fifteen states have adopted the Uniform Franchise Offering 
Circular (UFOC) according greater protections to franchisees resident 
in those states over those offered by the federal rule. The UFOC, to a 
great extent, came about because many states concluded that the federal 
Franchise Rule was outdated and therefore less effective.
    Today, we'll hear testimony from the Commission as to its review 
efforts and its proposed amendments to the Rule. We'll also hear of 
proposed amendments offered by others, most of which share the 
objective of harmonizing the FTC Franchise Rule disclosure requirements 
with those of the UFOC. I commend those efforts. I strongly encourage 
that the Commission undertake its review and amending of the Rule on an 
expedited timetable. I also support the promulgation of a separate rule 
for business opportunity franchises as they pose substantially 
different questions and challenges than business format franchises.
    Amending the Rule so that it better serves its intended purpose: 
protection of prospective franchisees, through the pre-sale disclosure 
of pertinent facts about the franchise is one thing. Enforcing the Rule 
is something different. The Commission reports that since the Rule's 
promulgation in 1979, it has brought over 200 franchise and business 
opportunity cases under both the rule and section 5 of the FTC Act. 
Meanwhile, just in the period 1993-99, the Commission received nearly 
4000 complaints. The question that I have for the Commission is: why so 
few prosecutions?
    Finally, as members, we are typically approached by aggrieved 
franchisees, be they friends or constituents, with some degree of 
frequency. Most of the issues that trouble those franchisees arise 
post-sale or after the signing of the franchise contract and as such 
don't implicate the disclosure requirements of the FTC Franchise Rule. 
For example, many franchisees have complained about the renewal and 
supply sourcing policies (whether the franchisee was required to buy 
all supplies from the franchisor or its designee) of their respective 
franchisors. Moreover, the franchisees identify encroachment as yet 
another contentious problem--where a new franchisee was assigned a 
franchise territory that encroached on a pre-existing franchisee's 
territory. These are clearly post-sale issues. Nonetheless, I wonder to 
what extent can these post-sale problems be avoided or lessened with a 
``better'' disclosure rule. Some will argue that post-sale problems 
cannot be effectively addressed by ``any'' disclosure rule. That may be 
true. Still, we, specifically the Commission, should strive to 
promulgate a ``new'' Franchise Rule that better informs a prospective 
franchisee of some of the challenges, such as encroachment and renewal, 
that he/she may face post-sale. If the federal franchise rule is not 
made more effective, i.e., responsive to problems that plague 
franchisor-franchisee relations today, then the call by some for a 
federal law governing aspects of post-sale relationship will not 
subside. After all in the past Congress has enacted post-sale 
relationship statutes applicable to two of the largest industries 
within the franchising world: the auto and gasoline retailers.

    Mr. Rush. Thank you, Mr. Chairman. Thank you for holding 
this hearing on the FTC's Franchise Rule. There are important 
questions about how this 23-year-old rule affects the industry 
it regulates, as well as the efficiency of the administrative 
processes at the FTC. The FTC began its review of the Franchise 
Rule in April 1995. However, noticed rule changes were proposed 
in 1997. That rule, however, remains unaltered even until 
today.
    Now, after 7 years the FTC first sought public comment 
regarding amendments to the rule. Now the Commission tells us 
that it will release a staff report, a staff report, I remind 
you, not even a proposed final rule, by early 2003. I hope the 
Commission can tell us a little bit more today about these 
deliberations and shed some light on the significant delay.
    The substance of the Franchise Rule also raises important 
questions. The relationship between franchisees and franchisors 
is unique among American businesses. As franchising becomes 
more prevalent in our Nation's economy, the nature of that 
relationship should be explained more closely and examined much 
more closely by the FTC and by the Congress.
    Are franchisees consumers of a product made by franchisors? 
If so, should they receive additional consumer protections 
enforced by the FTC? Or are they merely business partners whose 
relationship is more appropriately governed by State contract 
law? And most importantly, are potential franchisees adequately 
informed about the nature of this relationship and the pitfalls 
that they may face?
    Today we will be hearing from representatives on both sides 
of the issue as well as the FTC and State Attorney General. I 
look forward to hearing their views as our subcommittee begins 
its inquiry into the franchise industry.
    Thank you, Mr. Chairman. I yield back the balance of my 
time.
    Mr. Stearns. Thank you. Mr. Shimkus for an opening 
statement.
    Mr. Shimkus. Thank you, Mr. Chairman, and the benefits of 
small business and job creation is indisputable. However, we 
have all read and heard horror stories over the years of small 
business people buying into franchises and then running into a 
bait and switch problem. Franchising has become a major engine 
in economic growth in our country and around the world. With as 
many as 8 million Americans employed by franchises, it is 
important to ensure that franchisors abide by a code of 
fairness and truthfulness in dealing with their franchisees.
    The GAO issued a report in July 2001 on the FTC regulation 
of franchising. Among its findings were that complaints by 
franchisees to the FTC had risen dramatically and that 92 
percent of these complaints are specifically about the post-
sale relationship. However, the FTC repeatedly complained of a 
lack of resources and authority to address the post-sale 
relationship issues.
    I look forward to today's hearing and the panel's report 
and views on what the Federal Government's role should be in 
regulation of franchising and what can be done to improve the 
FTC's franchising rule. Again, I thank Chairman Stearns for 
holding this important consumer protection hearing, and with 
that, Mr. Chairman, I yield back the balance of my time.
    Mr. Stearns. I thank my colleague.
    [Additional statements submitted for the record follow:]
    Prepared Statement of Hon. Charles F. Bass, a Representative in 
                Congress from the State of New Hampshire
    Mr. Chairman, I thank you for holding this hearing. I am pleased 
the Subcommittee has the opportunity to revisit the issue
    With 8 million Americans employed by franchises, the FTC franchise 
rule is one that affects a significant segment of the population. Given 
that the commission has been collecting comments since 1997 and that 
the rule was promulgated 23 years ago, it is timely to consider this 
disclosure rule again in light of more recent legislation and business 
trends.
    These relationship issues regarding policy disclosure, FTC 
regulation, enforcement and even corporate governance may require 
renewed consideration and deliberation and I look forward to today's 
testimony.
    I yield back to the Chairman.
                                 ______
                                 
 Prepared Statement of Hon. W.J. ``Billy'' Tauzin, Chairman, Committee 
                         on Energy and Commerce
    Thank you, Mr. Chairman, for calling this hearing today on the 
Federal Trade Commission's Franchise rule. It has been some time since 
this Committee examined the guidelines set forth in the Rule, and so I 
am pleased we have two distinguished panels here today to bring us up 
to speed.
    The ``franchise'' is one of this county's most successful business 
relationships. Franchise systems continue to provide the widest 
possible entrepreneurial opportunities for citizens of this country. 
Today, with more than 75 industries operating within the franchising 
format, franchise companies are major contributors in the development 
of the management and technical skills that help to produce an 
experienced work force and to support the economic vitality of this 
country. There are hundreds of thousands of people who have succeeded 
in this country by investing in franchises--from McDonald's 
restaurants, to Hilton hotels, to 7-11 convenience stores.
    As with any other business relationship, however, franchise 
relationships have certainly had their share of problems. In order to 
prevent abuses, the FTC implemented the Franchise Rule in 1979 to 
ensure that the parties to any franchise agreement received pre-sale 
disclosures of important franchise information. Today, every U.S. 
franchisor must disclose certain information to prospective franchise 
buyers so both parties can enter into an agreement having made informed 
business decisions.
    To the Commission's credit, the rules have not changed 
substantially since they were first implemented. But, as Mr. Beales, 
our witness from the FTC, will tell us today, the Franchise Rule covers 
both franchises and so-called business opportunity enterprises. In a 
business opportunity, the promoter promises to provide the buyer with 
equipment, such as vending machines, used to sell products or services.
    It is in the area of ``business opportunities'' that the FTC is 
receiving an increasing number of complaints. Of the 170 cases the FTC 
brought in 2001 under the Commission's Franchise Program, a startling 
148 of those were business opportunity scams. I am heartened to see the 
FTC, as the agency empowered to protect consumers against schemes 
designed to separate people from their money, is taking aggressive 
enforcement steps to address the growing problems seen in this area.
    Since the Franchise rule has been in place for 23 years, it is 
about time the Commission took a fresh look and considered appropriate 
amendments. I understand that the FTC is currently in the process of 
making amendments to the Franchise Rule to reflect changes in the 
marketplace and to further increase the pre-sale disclosures. I look 
forward to hearing about these proposed changes and the impact they 
will have for both franchisees and franchisors.
    I thank our witnesses for appearing here today and, again, I thank 
the Chairman for holding this hearing. Thank you.

    Mr. Stearns. We welcome our first witness, Mr. Howard 
Beales, Director of the Bureau of Consumer Protection in the 
FTC. Mr. Beales has been before us before. We welcome you, and 
we look forward to your opening statement.

     STATEMENT OF J. HOWARD BEALES III, DIRECTOR, BUREAU OF 
         CONSUMER PROTECTION, FEDERAL TRADE COMMISSION

    Mr. Beales. Thank you, Mr. Chairman. It is always a 
pleasure to be here, and thank you also to the members of the 
subcommittee. I am pleased to be here today to discuss the 
FTC's Franchise Rule. The written statement that I have 
submitted represents the views of the Federal Trade Commission. 
My oral statement and responses to questions are my own and not 
necessarily those of the Commission or any individual 
Commissioner.
    The Franchise Rule seeks to facilitate informed decisions 
and to prevent deception in the sale of franchises. Rather than 
regulate the substance of the terms controlling the 
relationship, the rule requires franchisors to provide 
prospective franchisees with material information that they 
need prior to the sale. As you know, the rule works in 
conjunction with section 5 of the FTC Act, which prohibits 
unfair and deceptive practices. The Commission aggressively 
investigates and prosecutes violations of the Franchise Rule 
and section 5 against franchisors and business opportunity 
sellers. To date the Commission has brought over 200 such law 
enforcement actions, involving over 640 entities and 
individuals.
    I am pleased to tell you that just last week the Commission 
announced the filing of over 70 new cases by the FTC, the 
Department of Justice and our State partners in a FTC 
coordinated sweep against fraudulent business opportunities and 
related scams. The majority of the FTC's franchise related 
actions have targeted business opportunities.
    As you know, the Franchise Rule generally covers two 
different types of business arrangements, franchises and 
business opportunity ventures. Although the Commission receives 
few franchisee complaints alleging fraud, deception or 
substantive rule violations by franchisors, the same cannot be 
said of business opportunity sellers. Many business 
opportunities are outright scams that disappear shortly after 
taking consumers money.
    Unfortunately, compliance with the Franchise Rule by 
business opportunity sellers is low. This fact is amply 
demonstrated by the analysis of our complaint data base 
contained in the Commission's prepared testimony. We receive 
far more consumer complaints about the sale of business 
opportunities than we receive about traditional franchises. The 
complaint data also indicate that unlike complaints about 
traditional franchises, business opportunity fraud is a leading 
cause of consumer injury.
    The same pattern is evident when we examine the number of 
complaints about particular sellers. Although we often receive 
large numbers of complaints about a single business opportunity 
scam, we rarely receive complaint from more than one franchisee 
about the same franchisor. Accordingly, the Commission 
continues to focus much of its Franchise Rule enforcement 
resources on prosecuting business opportunity frauds.
    Finally, as the subcommittee is aware, the Commission is in 
the process of updating the Franchise Rule. In 1999, the 
Commission published a notice of proposed rulemaking which sets 
forth the text of a proposed rule. Among other things, the 
proposal would review the rule in four material respects. It 
would focus exclusively on franchise issues so that business 
opportunities would be handled in a separate rulemaking.
    Second, the proposal would revise the Franchise Rule along 
the model of the uniform franchise offering circular 
guidelines.
    Third, the proposal would update the rule to address 
franchise disclosures made via the Internet.
    Finally, the proposal would provide prospective franchises 
with more information about the state of the franchise 
relationship.
    We are hopeful of forwarding a staff report to the 
Commission, which would be the next stage in this process, at 
some point in the fall. That staff report would then be subject 
to public comment under the FTC's procedures.
    Mr. Chairman, the FTC greatly appreciates the opportunity 
to testify, and I would be happy to answer any questions that 
you or members of the committee may have.
    [The prepared statement of J. Howard Beales III follows:]
   Prepared Statement of J. Howard Beales, III, Director, Bureau of 
             Consumer Protection, Federal Trade Commission
    Mr. Chairman, I am J. Howard Beales, III, the Director of the 
Federal Trade Commission's Bureau of Consumer Protection.1 
On behalf of the Commission, I appreciate this opportunity to provide 
information to the Subcommittee on franchising and the Commission's 
enforcement of the Franchise Rule.2 As you know, the 
Commission promulgated the Franchise Rule in the late 1970s, and since 
that time has rigorously enforced its provisions. Since the Franchise 
Rule was enacted, the Commission has brought over 200 franchise and 
business opportunity cases against over 640 entities and individuals. 
Indeed, just last week, the Commission announced its seventh joint law 
enforcement sweep in this field. Together with the Department of 
Justice and our state partners, we have filed over 70 cases against 
business opportunities and related schemes, the most prevalent and 
persistent problem in Franchise Rule enforcement.
---------------------------------------------------------------------------
    \1\ The views expressed in this statement represent the views of 
the Commission. My oral statement and responses to any questions you 
may have are my own and are not necessarily those of the Commission or 
any Commissioner.
    \2\ Disclosure Requirements and Prohibitions Concerning Franchising 
and Business Opportunity Ventures, 16 C.F.R. Part 436. The Commission 
also enforces over 30 rules governing specific industries and 
practices, for example: the Funeral Rule, 16 C.F.R. Part 453, which 
requires funeral providers to give consumers accurate price lists that 
itemize goods and services offered; and the Telemarketing Sales Rule, 
16 C.F.R. Part 310, which defines and prohibits deceptive telemarketing 
practices and other abusive telemarketing practices.
---------------------------------------------------------------------------
    The FTC's mission is to protect American consumers by taking action 
against unfair or deceptive acts or practices and by promoting vigorous 
competition. To that end, the Commission enforces the Federal Trade 
Commission Act (``FTC Act''), which prohibits unfair methods of 
competition and unfair or deceptive acts or practices in or affecting 
commerce.3 The FTC Act also empowers the Commission to 
prescribe rules that define with specificity acts or practices that are 
unfair or deceptive.4 One such rule is the Commission's 
Franchise Rule.5 Today, I will describe the Franchise Rule 
and the Commission's enforcement history. I will then discuss franchise 
relationship issues and the Commission's ongoing rule amendment 
proceeding.
---------------------------------------------------------------------------
    \3\ 15 U.S.C. Sec. 45(a).
    \4\ 15 U.S.C. Sec. 57a.
    \5\ In many respects, franchisees are not ordinary consumers. For 
example, the Magnuson-Moss Warranty Act defines ``consumer'' as ``a 
buyer . . . of any consumer product.'' In turn, it defines ``consumer 
product'' in relevant part as ``any tangible personal property which is 
distributed in commerce and which is normally used for personal, 
family, or household purposes.'' 15 U.S.C. Sec. 2301. Similarly, the 
Electronic Signatures in Global and National Commerce Act, 15 
U.S.C.Sec. 7001 et seq. defines ``consumer'' as ``an individual who 
obtains, through a transaction, products or services which are used 
primarily for personal, family, or household purposes . . .'' Id. at 
Sec. 7006. Franchisees, in contrast, do not just buy products, but 
invest in a business system. Indeed, several states have held that 
franchisees are not ``consumers'' entitled to protection under state 
general consumer protection statutes. E.g., West Coast Franchising Co. 
v. WCV Corp., 30 F. Supp. 2d 49 (E.D. Pa. 1998); Sparks Tune Up Centers 
v. Addison, Civ. No. 89-1355, 1989 U.S. Dist. LEXIS 7413 (E.D. Pa. 
1989)(applying Ohio law). This view, however, is not universal. See, 
e.g., Hofsettler v. Fletcher, 905 F.2d 897 (6th Cir. 1988); Deerman v. 
Fed. Home Loan Mortg. Corp., 955 F. Supp. 1393 (N.D. Ala. 1997); LJS 
Co. v. Marks, 480 F. Supp. 241 (S.D. Fla. 1979).
---------------------------------------------------------------------------
                             i. background
A. The Franchise Rule Provides Important Information And Prohibits 
        Deceptive Practices
    When the Commission promulgated the Franchise Rule in the 1970s, 
the Commission determined that prospective franchisees needed certain 
critical information from franchisors. Without adequate information, 
prospective franchisees risked serious economic injury as a result of 
misrepresentations or omissions of material facts about the franchise 
business under consideration. Prevalent deceptive practices included 
the misrepresentation of: (1) the nature of the franchise; (2) the 
range of goods and services, such as supplies, equipment, and training, 
to be provided as part of the franchise package; (3) the value and 
profitability of the franchise; and (4) the franchisor's financial 
stability and prior experience.6
---------------------------------------------------------------------------
    \6\ See Franchise Rule Statement of Basis and Purpose, 43 Fed. Reg. 
59,614, 59,624-632 (Dec. 21, 1978).
---------------------------------------------------------------------------
    The Franchise Rule seeks to facilitate informed decisions and to 
prevent deception in the sale of franchises by requiring franchisors to 
provide prospective franchisees with material information prior to the 
sale. Specifically, the Franchise Rule requires franchisors to make 
material disclosures in five categories: (1) the nature of the 
franchisor and the franchise system; (2) the franchisor's financial 
viability; (3) the costs involved in purchasing and operating a 
franchised outlet; (4) the terms and conditions that govern the 
franchise relationship; and (5) the names and addresses of current 
franchisees who can share their experiences within the franchise 
system, thus helping the prospective franchisee to verify independently 
the franchisor's claims. In addition, franchisors must have a 
reasonable basis and substantiation for any earnings claims made to 
prospective franchisees, as well as disclose the basis and assumptions 
underlying any such earnings claims.
B. The Franchise Rule Covers Sales Of Franchises And Business 
        Opportunity Ventures
    The Franchise Rule generally covers two different types of business 
arrangements: franchises and business opportunity ventures. Franchises 
typically involve retail outlets that bear the franchisor's trademark 
and follow the franchisor's business operations model, such as fast-
food restaurants, hotels, and automotive repair shops. These are 
commonly known as ``business-format'' franchises.7 Business 
opportunities, on the other hand, often do not entail a trademark or 
detailed business plan. In a business opportunity, the promoter 
typically promises to provide the buyer with equipment that is used to 
sell products or services to the public, such as vending machines, rack 
displays, pay phones, or medical billing software. The business 
opportunity promoter also frequently promises to find the buyer a 
market for the products or services sold by securing locations or 
accounts for the equipment used in the business, such as placing 
vending machines or rack displays in airports or bowling alleys, or 
providing the names of doctors seeking medical billing assistance.
---------------------------------------------------------------------------
    \7\ The Franchise Rule also covers ``product franchises,'' in which 
the franchisee typically distributes products manufactured by the 
franchisors, such as automobile dealerships. See Franchise Rule, Final 
Interpretive Guides, 44 Fed. Reg. 49,966, 49,966-967 (Aug. 24, 1979).
---------------------------------------------------------------------------
C. Fifteen States Also Have Franchise Disclosure Laws
    The FTC is not the only governmental entity to address pre-sale 
disclosure of franchise information. In addition to the FTC, 15 states 
require pre-sale disclosure in franchise sales in the form of a Uniform 
Franchise Offering Circular (``UFOC'').8 In many respects, 
the UFOC Guidelines' required disclosures are substantially similar to 
those of the Franchise Rule. Both formats, for example, require a 
description of: (1) the franchisor and its business; (2) prior 
litigation and bankruptcies; (3) initial and ongoing fees; (4) 
franchisor and franchisee obligations and other terms of the franchise 
contract; (5) restrictions on sales; and (6) rights to renew and 
terminate the franchise. In addition, both formats require 
substantiation of any earnings claims, statistics on existing 
franchisees, a list of franchisee references, and audited financial 
statements.9(3) computer system requirements; and (4) the 
names and addresses of former as well as current franchisees.
---------------------------------------------------------------------------
    \8\ These states are California, Hawaii, Illinois, Indiana, 
Maryland, Minnesota, Michigan, New York, North Dakota, Oregon, Rhode 
Island, South Dakota, Virginia, Washington, and Wisconsin. Twelve of 
these states review and approve franchisors' UFOCs before they can be 
used in the state. In order to reduce franchisors' compliance burdens, 
the Commission will accept a UFOC in lieu of a franchise disclosure 
document.
    \9\ The UFOC Guidelines, however, focus exclusively on franchise 
sales; business opportunities are regulated to varying degrees in 22 
states. The UFOC Guidelines also contain more expansive disclosures 
than the Franchise Rule. For example, the UFOC Guidelines require the 
disclosure of: (1) regulations specific to the industry in which the 
franchisee will conduct business; (2) litigation or a bankruptcy 
involving a franchisor's predecessor;
---------------------------------------------------------------------------
    Because a UFOC is accepted by both the states and the FTC, the UFOC 
Guidelines have effectively become the national franchise disclosure 
standard.
                     ii. franchise rule enforcement
    The Franchise Rule has the force and effect of law, and it may be 
enforced through civil penalty actions in federal courts.10 
The FTC Act authorizes courts to impose civil penalties of not more 
than $11,000 per compliance violation. In addition, the Commission may 
seek to obtain preliminary and permanent injunctive relief (including 
the full range of equitable remedies) in federal court.11 
Such actions often result in monetary redress made to injured 
consumers.
---------------------------------------------------------------------------
    \10\ 15 U.S.C. Sec. 45(m)(1)(A).
    \11\ 15 U.S.C. Sec. 53(b).
---------------------------------------------------------------------------
    To date the Commission has brought over 200 law enforcement actions 
under the Franchise Rule and Section 5 of the FTC Act against 
franchisors and business opportunity ventures, involving over 640 
entities and individuals. Many of those actions have been against well-
known franchise systems. For example, the Commission brought suit 
against Minuteman Press, a national printing franchisor.12 
That case, which involved a six-month trial, resulted in a settlement 
in which the defendants paid over $3 million in consumer redress.
---------------------------------------------------------------------------
    \12\ FTC v. Minuteman Press, Int'l, Civ. No. CV-93-2496 
(DRH)(E.D.N.Y. 1993). See also, e.g., FTC v. Car Wash Guys, Int'l, 
Inc., Civ. No. 00-8197 (C.D. Cal. 2000); FTC v. Tower Cleaning Sys., 
Inc., Civ. No. 96-58-44 (E.D. Pa. 1996); U.S. v. Tutor Time Child Care 
Sys., Inc., Civ. No. 96-2603 (N.D. Cal. 1996); FTC v. Indep. Travel 
Agencies of Am. Assoc., Civ. No. 95-6137-CIV-Gonzalez (S.D. Fla. 1995); 
FTC v. Mortg. Serv. Assoc., Civ. No. 395-CV-1362 (AVC) (D. Conn. 1995); 
U.S. v. Jani-King Int'l, Inc., Civ. No. 3-95-CV-1492-G (N.D. Tex. 
1995).
---------------------------------------------------------------------------
A. Distinctions Between Business-Format Franchisors And Business 
        Opportunity Sellers
    Our law enforcement experience shows that business-format 
franchising has matured since the promulgation of the Franchise Rule in 
the 1970s.13 Many franchise systems today are established, 
well-respected, household names.14 While there is no 
question that fraud may occur in the sale of some franchises, the 
Franchise Rule's pre-sale disclosure requirements provide valuable 
information to help protect against fraud. Where Rule violations occur, 
it is mostly among small, start-up franchisors who may not be well-
versed in the Franchise Rule's disclosure requirements.15 As 
a result, the Commission receives few franchisee complaints alleging 
fraud, deception, or substantive Rule violations by business-format 
franchisors.
---------------------------------------------------------------------------
    \13\ Since the promulgation of the Franchise Rule and the UFOC 
Guidelines in the 1970s, no additional state has sought to adopt 
franchise disclosure regulation. Indeed, several states, including 
Michigan, Wisconsin, and Indiana, have eliminated routine review of 
UFOC filings.
    \14\ The franchise legal community is also well-organized. For 
example, the American Bar Association's Forum on Franchising has nearly 
600 members. Franchisors are also represented by the International 
Franchise Association (``IFA'') and the National Franchise Council. 
Franchisees are represented by various groups including the IFA, 
American Franchisee Association, and American Association of 
Franchisees and Dealers. In addition, we have recently seen the growth 
of franchisee councils and independent franchisee associations that 
represent franchisee interests, such as the National Franchise 
Association (the association of Burger King franchisees).
    \15\ In such instances, the FTC staff may recommend that the 
alleged violation be addressed through a referral to the National 
Franchise Council (``NFC''), a private industry group comprised of a 
limited number of select franchise systems, mostly in the hotel and 
food industries. Franchisors who agree to be referred to the NFC's 
Alternative Law Enforcement Program receive Franchise Rule compliance 
training, compliance monitoring, and in, some instances, participate in 
mediation of franchisee complaints. This approach to addressing minor, 
non-fraudulent violations of the Franchise Rule is consistent with the 
goals of the Small Business Regulatory Fairness Enforcement Act, 5 
U.S.C. Sec. 601, et seq., which, among other things, requires agencies 
to consider reducing or waiving civil penalties in appropriate 
circumstances.
---------------------------------------------------------------------------
    Unfortunately, the same cannot be said of business opportunity 
sellers. Many business opportunities are outright scams that disappear 
shortly after taking consumers' money. Compliance with the Franchise 
Rule by business opportunity sellers is low. A 2001 Staff Review of the 
Commission's Franchise Program reported that the Commission brought 170 
franchise or business opportunity cases against 330 entities and 305 
individuals between 1993 and 2001.16 Of the 170 cases, 148 
were against business opportunity schemes.17 Commission 
actions have involved, for example, the deceptive sale of vending 
machine 18 and rack display 19 opportunities; pay 
telephones, 20 fax, 21 and Internet access 
22 ventures; 900-number telephone schemes; 23 and 
medical billing opportunities.24 Almost all of these cases 
involved the making of false or unsubstantiated earnings 
representations in violation of the Rule and most alleged that the 
promoter failed to provide prospects with any disclosures whatsoever.
---------------------------------------------------------------------------
    \16\ Bureau of Consumer Protection Staff, Franchise and Business 
Opportunity Program Review 1993-2000 (June 2001)(``Staff Review'') at 
33. A copy of this Staff Review is available at the Commission's Web 
site at: http://www.ftc.gov/bcp/reports/franchise9301.pdf.
    \17\ Similarly, in its 2001 audit of the Commission's Franchise 
Program, the General Accounting Office (``GAO'') found that, between 
1993 and 2000, the Commission staff opened 332 franchise and business 
opportunity investigations, the overwhelming majority of which involved 
business opportunities. GAO, Federal Trade Commission Enforcement of 
the Franchise Rule (July 2001)(``GAO Report'') at 13-15. See also 
Appendix V: Information on Business Opportunity and Franchise Court 
Cases Filed by FTC During 1993-2000, id. at 49-64.
    \18\ See, e.g., FTC v. Pathway Merch., Inc., Civ. No. 01-CIV-8987 
(S.D.N.Y. 2001); FTC v. Hi Tech Mint Sys, Inc., Civ. No. 98 CIV 5881 
(S.D.N.Y. 1998); U.S. v. PVI, Inc. Civ. No. 98-6935 CIV-Ferguson (S.D. 
Fla. 1998); FTC v. Telecard Dispensing Corp., Civ. No. 98-7058-CIV 
(S.D. Fla. 1998); FTC v. Hi Tech Mint Sys., Inc., Civ. No. 98-CIV-5881 
(N.D.N.Y. 1998); FTC v. Vendall Mktg. Corp., Civ. No. 94-6011-HO (D. 
Or. 1994); FTC v. Vendorline, Inc., Civ. No. 2:92-cv-129-WCO (N.D. Ga. 
1992). See also FTC News Release: FTC Announces Operation ``Vend Up 
Broke'' (Sept. 3, 1998)(FTC and 10 states announce 40 enforcement 
actions against fraudulent vending business opportunities).
    \19\ See, e.g., U.S. v. QX Int'l, Civ. No. 3:98CV453-D (N.D. Tex. 
1998); FTC v. Carousel of Toys, Civ. No. 97-8587 CIV-Ungaro-Benages 
(S.D. Fla. 1997); FTC v. Urso, Civ. No. 97-2680 CIV-Ungaro-Benages 
(S.D. Fla. 1997); FTC v. Infinity Multimedia, Inc., Civ. No. 
966671CIVGonzalez (S.D. Fla. 1996); FTC v. Andrisani, Civ. No. 93-6511 
(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)(FTC and eight states file 18 enforcement actions 
against sellers of bogus business opportunities that use trademarks of 
well-known companies).
    \20\ See, e.g., FTC v. Advanced Pub. Communications Corp., Civ. No. 
00-00515 CIV-Ungaro-Benages (S.D. Fla. 2000); FTC v. Ameritel Payphone 
Distrib., Inc., Civ. No. 00-0514 CV-Gold (S.D. Fla. 2000); FTC v. 
ComTel Communications Global Network, Inc., Civ. No. 96-3134-CIV-
Highsmith (S.D. Fla. 1996); FTC. v. Intellipay, Inc., Civ. No. H92-2325 
(S.D. Tex. 1992).
    \21\ See FTC v. Fax Corp. of Am., Inc., Civ. No. 90-983 (D. N.J. 
1990).
    \22\ See FTC v. Hart Mktg Enter., Civ. No. 98-222-Civ-T-23E (M.D. 
Fla. 1998). See also FTC v. FutureNet, Inc., Civ. No. CV-98-1113 GHK 
(BQRx) (C.D. Cal. 1998); FTC v. TouchNet, Inc., Civ. No. C98-0176 (W.D. 
Wash. 1998).
    \23\ See, e.g., FTC v. Bureau 2000 Int'l, Inc., Civ. No. 
961473DT(JR) (C.D. Cal. 1996); FTC v. Genesis One Corp., Civ No. 
CV961516MRP(MCX) (C. D. Cal.1996); FTC v. Innovative Telemedia, Inc., 
Civ. No. 968140 CIVFerguson (S.D. Fla. 1996).
    \24\ See, e.g., FTC v. Medicor LLC, Civ. No. CV01-1896 (CBM) (C.D. 
Cal. 2001); FTC v. Vaughn William, III, Civ. No. 00-01083 (C.D. Cal. 
2000); FTC v. Data Med. Capital, Inc., Civ. No. SACV991266 AHS (C.D. 
Cal. 1999); FTC v. Nat'l Consulting Group, Inc., Civ. No. 98 C 0144 
(N.D. Ill. 1998); FTC v. Marquette, Inc., Civ. No. 1:95-CV-1749-RLV 
(N.D. Ga. 1997); U.S. v. Island Automated Med. Serv., Inc., Civ. No. 
95-1110-CV-T-17(A) (M.D. Ga. 1995).
---------------------------------------------------------------------------
    In addition to violating the Franchise Rule, business opportunity 
sellers also frequently engage in a myriad of deceptive acts and 
practices in violation of Section 5 of the FTC Act in order to lure 
unsuspecting consumers to invest. For example, business opportunity 
sellers often disseminate false earnings projections and make false 
promises of exclusive market territories. In addition, they often use 
shill references or false testimonials to create the impression that 
their opportunity is safe and profitable. Typically, they also 
misrepresent the availability or profitability of locations for vending 
machines or other equipment used in the business; misrepresent their 
prior success; misrepresent assistance to be provided to the purchaser; 
and misrepresent the nature of their products or services.25
---------------------------------------------------------------------------
    \25\ Staff Review at 37-39.
---------------------------------------------------------------------------
B. The Commission's Law Enforcement Efforts Track Consumer Complaint 
        Data
    The Commission's law enforcement efforts described above track the 
breakdown of complaints the FTC receives. Overwhelmingly, the 
complaints the Commission receives involve the sale of business 
opportunities. The Commission's staff analyzed 4,512 franchise and 
business opportunity complaints in the Commission's Consumer 
Information System (``CIS'') database between 1993 and June 1999. Of 
the 4,512 complaints, 3,392 complaints--more than 75%--clearly involved 
business opportunities. An additional 832 complaints were against 
companies that did not appear on known lists of franchisors and most 
likely were business opportunities as well.26 Only 6% of the 
complaints pertained to traditional franchise arrangements. Complaints 
were lodged against 949 business opportunity sellers, but against only 
197 franchisors.
---------------------------------------------------------------------------
    \26\ Id. at 4-9.
---------------------------------------------------------------------------
    Injury to individual consumers resulting from business opportunity 
fraud is also among the highest levels of injury we see in consumer 
protection. The staff's analysis of complaint data between 1993 and 
June 1999 shows that more than 650 consumers each reported losses of at 
least $10,001. An additional 631 consumers each reported losses of 
between $5,001 and $10,000, and 621 between $1,001 and 
$5,000.27 Indeed, injury from business opportunity fraud 
consistently ranks among the top 10 product/service categories in the 
Commission's database based upon amount paid, often resulting in 
consumer losses of over $1 million each month.
---------------------------------------------------------------------------
    \27\ Id. at 17 (Chart C.5). The level of actual injury is probably 
much greater. Our review found that 727 business opportunity purchasers 
did not disclose how much they believed was lost through their 
investment. See Id. (Chart C.6).
---------------------------------------------------------------------------
    For these reasons, the Commission continues to focus much of its 
Franchise Rule enforcement and consumer educational resources 
28 on combatting business opportunity fraud. Indeed, since 
1995, the Commission has joined with the Department of Justice and 
state consumer protection agencies to bring seven joint law enforcement 
sweeps covering a variety of business opportunity ventures. The most 
recent of these sweeps occurred just last week--Operation Busted 
Opportunity, which targeted over 70 business opportunity and related 
schemes.
---------------------------------------------------------------------------
    \28\ In addition to law enforcement, the Commission has engaged in 
numerous consumer educational efforts to spread the word about business 
opportunity and related frauds. For example, the Commission's Office of 
Consumer and Business Education (``OCBE'') has generated nearly 20 
brochures and alerts on various business opportunities and related 
schemes (multi-level marketing, pyramids, work-at-home schemes). In 
fiscal year 2000 alone, OCBE distributed 169,120 printed copies of 
these materials and received 374,787 hits on its online versions. Staff 
Review at 61.
---------------------------------------------------------------------------
    The Commission will continue to work with its law enforcement 
partners to protect consumers from such frauds.
                 iii. franchise ``relationship'' issues
    One area of franchising that has received widespread attention in 
recent years is the nature of franchise relationships. The Franchise 
Rule requires the disclosure of material information concerning the 
sale of a franchise. It does not, however, regulate the substance of 
the terms that control the relationship between franchisors and 
franchisees. The Commission believes that the market is the best 
regulator of franchise sales, provided that prospective franchisees 
have full and complete disclosure of material information with which to 
conduct a due diligence investigation of the franchise offering.
    Nonetheless, we are aware that some franchisees, franchisee trade 
associations, and franchisee advocates have raised concerns about 
franchise relationships. Their concerns do not involve allegations of 
deception or fraud in the sale of franchises. Rather, they assert that 
the underlying relationship between franchisor and franchisee is often 
unfair, with the franchisor dictating the terms under which the 
franchisee will conduct business, often allegedly resulting in 
significant financial losses. Among other issues, franchisees have 
complained about: (1) lack of protected territories and encroachment by 
franchisors into their market location; (2) obligations to purchase 
supplies or inventory from specified providers, even if comparable 
items are available at cheaper prices from alternative suppliers; and 
(3) renewal of franchise agreements on restrictive or more onerous 
terms.29
---------------------------------------------------------------------------
    \29\ The Franchise Rule (as well as the UFOC Guidelines) addresses 
each of these issues through pre-sale disclosure. See 16 C.F.R. 
Sec. 436.1(a)(13)(territorial protections); Sec. 436.1(a)(10) (required 
suppliers); Sec. 436.1(a)(11)(revenue received by franchisor from 
required suppliers); Sec. 436.1(a)(15)(renewal and termination 
conditions).
---------------------------------------------------------------------------
A. The Commission Lacks Complaint Data that Would Indicate Franchise 
        Relationship Disputes Are a Prevalent Problem
    Although the Commission does not doubt that individual franchisees 
may have experienced abuses in their relationships with franchisors, 
the Commission is unaware of any evidence that relationship issues are 
prevalent throughout franchising. As a preliminary matter, we do not 
know the exact number of franchisees in the United States. In its 2001 
report on the Franchise Rule, the GAO stated that there are more than 
320,000 franchised units in the United States.30 
Accordingly, we can reasonably assume that there are hundreds of 
thousands of franchisees. Yet, FTC complaint data for the period 1993 
through June 1999 show that only 288 franchisees filed complaints with 
the Commission. Of these, 134 contained insufficient information to 
determine any specific allegation. Of the remaining 154 complaints, 141 
raised post-sale issues involving 102 companies.31 It 
appears that franchisees in about 95% of the approximate 2,500 
franchise systems operating in North America 32 did not file 
a single relationship complaint with the Commission during nearly seven 
years.33 Moreover, the vast majority of companies that were 
the subject of a franchise complaint generated only a single complaint. 
For example, 91 companies generated only one complaint each, while only 
one company generated more than five complaints. In short, complaints 
to the Commission rarely present a pattern of law violations by 
business-format franchise systems.34
---------------------------------------------------------------------------
    \30\ GAO Report at 5.
    \31\ See Id. at 22.
    \32\ See Bond's Franchise Guide (1998 ed.) at 9, 25 (estimating 
there are 2,500 American and Canadian franchisors).
    \33\ The complaint data noted above do not necessarily represent an 
exact accounting of all correspondence that was submitted to the 
Commission during the relevant time period. As noted in the Staff 
Review, complaint data prior to 1997, especially telephone calls, were 
not routinely captured in a centralized database. This changed in 1997, 
when the Commission created the Consumer Response Center, which 
standardized Commission complaint handling. For these reasons, data 
submitted to the Commission after 1996 is the most complete. 
Nonetheless, the CIS data analyzed in the Staff Review are the single 
best source of complaint information available to the Commission both 
before and after 1997. See Staff Review at 4.
    \34\ It is possible that franchisees may have complained to state 
agencies. However, as noted below, the GAO found that the states 
contacted during its audit did not have readily available and 
statistically reliable data on the extent and nature of franchise 
relationship problems. Also, to the extent that states contribute data 
to the Commission's Consumer Sentinel database, franchisee complaint 
information to the states would have been included in the complaint 
data analyzed by the Commission's staff.
---------------------------------------------------------------------------
    The lack of relationship complaints in business-format franchising 
is consistent with the findings of the GAO. After conducting an inquiry 
into the scope of franchise relationship issues, the GAO concluded:
          The extent and nature of franchise relationship problems are 
        unknown because of a lack of readily available, statistically 
        reliable data--that is, the data available are not 
        systematically gathered or generalizable. According to FTC 
        staff, data FTC has collected, while limited, suggest that 
        franchise relationship problems are isolated occurrences rather 
        than prevalent practices. Franchise trade association officials 
        pointed to indicators or anecdotal information to support their 
        views regarding franchise relationship problems, but they were 
        not aware of any statistically reliable data on the extent and 
        nature of these problems. Likewise, none of the nine states we 
        contacted--eight of which have franchise relationship laws--had 
        readily available, statistically reliable data on the extent 
        and nature of franchise relationship problems.35
---------------------------------------------------------------------------
    \35\ GAO Report at 4 and 21.
---------------------------------------------------------------------------
B. Franchise Relationship Issues Are Determined by State Contract Law
    Franchise relationship issues are generally governed by the private 
contractual relationship between the franchisor and franchisee. To the 
extent that there are contract disputes, these are appropriately 
resolved under applicable state law. As noted above, the Franchise Rule 
is designed to ensure that franchisees have time to review all material 
terms and conditions of the franchise relationship, and an opportunity 
to seek legal, accounting, and marketing advice as well as the 
opportunity to speak to both former and current system franchisees 
before entering into a franchise agreement.
    It has been suggested by some that the Commission could use its 
unfairness authority to address franchise relationship issues. However, 
the Commission's unfairness authority is limited. Economic injury to 
franchisees alone is insufficient. Section 5 of the FTC Act provides 
that the Commission does not have the authority to declare an act or 
practice unfair unless it meets three specific criteria: (1) the act or 
practice causes or is likely to cause substantial injury; (2) that is 
not outweighed by countervailing benefits to consumers or to 
competition; and (3) is not reasonably avoidable.36
---------------------------------------------------------------------------
    \36\ This definition of unfairness was codified by Congress in the 
1994 amendments to the FTC Act at 15 U.S.C. Sec. 5(n). See also Orkin 
Exterminating Co., 108 F.T.C. 263, aff'd Orkin Exterminating Co. v. 
FTC, 849 F.2d 1354, reh'g denied, 859 F.2d 928 (11th Cir. 1988), cert. 
denied, 488 U.S. 1041 (1989).
---------------------------------------------------------------------------
    Even where there is substantial injury to franchisees, the second 
and third criteria must be met. Franchise systems, like all businesses, 
are influenced by ordinary market forces, and franchisors may want 
franchise agreements that maximize their ability to respond quickly to 
market changes. Therefore, a franchisor's choice of contract terms and 
conditions is often based upon some economic rationale that is designed 
to benefit consumers and/or the system's existing franchisees. The 
benefits flowing from these contractual terms may outweigh complaints 
or allegations of ``oppression'' by individual complainant-franchisees.
    Further, the Commission would be required to establish that 
contractual provisions that prospective franchisees voluntarily read, 
agreed to, and signed are not reasonably avoidable. This would be 
difficult because, under the Franchise Rule, prospective franchisees 
receive a disclosure document at least 10 business days before they are 
required to sign the franchise agreement. Presumably, every prospective 
franchisee also has the opportunity to review the franchise agreement 
before signing, seek legal, accounting, and marketing advice, as well 
as to speak to both former and current system franchisees. In short, it 
would not be appropriate for the Commission to second-guess a 
prospective franchisee's wisdom in signing a particular franchise 
agreement, as long as the prospective franchisee is forewarned about 
the legal consequences of his or her actions.
                             iv. rulemaking
    As the Subcommittee is probably aware, the Commission is in the 
process of updating the Franchise Rule.37 In 1999, the 
Commission published a Notice of Proposed Rulemaking (``NPR''), which 
set forth the text of a proposed revised Rule. Among other things, the 
proposal would revise the Rule in four material respects. First, it 
would focus exclusively on franchise issues. In the NPR, the Commission 
proposed that business opportunities be addressed in a separate 
rulemaking procedure that would focus narrowly on appropriate 
disclosures and, more importantly, on prohibitions necessary to prevent 
persistent fraud in that area. Second, the proposal would revise the 
Franchise Rule along the UFOC Guidelines model. This would reduce 
inconsistencies between federal and state disclosure laws and reduce 
compliance burdens. Third, the proposal would update the Rule to 
address new technologies, in particular the sale of franchises through 
the Internet. Fourth, the proposal would provide prospective 
franchisees with more information about the state of the franchise 
relationship. While specific complaints by franchisees are relatively 
few, as noted above, there remains considerable support among 
franchisee associations and franchisee advocates for greater disclosure 
of information from which a prospective franchisee can assess the 
quality of the relationship he or she will be entering.
---------------------------------------------------------------------------
    \37\ The rule amendment process began with a review of the Rule in 
1995, 60 Fed. Reg. 17,656 (April 7, 1995), and was followed by the 
publication of an Advance Notice of Proposed Rulemaking in 1997, 62 
Fed. Reg. 9,115 (February 28, 1997), and a Notice of Proposed 
Rulemaking in 1999, 64 Fed. Reg. 57,294 (October 22, 1999).
---------------------------------------------------------------------------
    The next step in the rule amendment process is the publication of a 
staff report that analyzes the record to date and offers specific 
recommendations for further fine-tuning of the NPR proposal. Because 
the rulemaking is ongoing, we cannot, at this time, comment on any 
substantive aspect of the proposed rule or its implementation. 
Nonetheless, we note that several NPR proposals, if ultimately adopted 
by the Commission, would give prospective franchisees expanded 
information with which to assess the franchise offering and the 
relationship between the franchisor and franchisee. For example, these 
proposals would: (1) alert prospective franchisees about the 
availability of the Commission's Consumer Guide to Buying a Franchise, 
which contains advice on how to read a disclosure document; (2) 
increase franchisors' disclosures about prior litigation with 
franchisees; (3) warn prospective franchisees about the consequences of 
purchasing an unprotected territory and not to rely on unauthorized 
financial performance information; and (4) make available information 
about franchisor-sponsored and independent franchisee associations.
                             v. conclusion
    Based upon the Commission's two decades of experience in enforcing 
the Franchise Rule, it is clear to us that deceptive business 
opportunity sales, rather than business-format franchise sales, remains 
a persistent cause of significant injury to American consumers. The 
Commission will continue to dedicate significant law enforcement 
resources to targeting this problem, as well as consider promulgating a 
separate business opportunity trade regulation rule that will prohibit 
specific practices that often underlie fraudulent business opportunity 
schemes.
    Thank you for this opportunity to describe for the Committee the 
Commission's Franchise Rule program. I will be pleased to respond to 
your questions.

    Mr. Stearns. I thank you, Mr. Beales. It is interesting, I 
don't even think most franchisees know that they can even 
complain to the FTC. And how do you get the word out? I mean 
how are people to know that you are an agency to complain to 
before they sign their contracts, not post-contract?
    Mr. Beales. Well, we do a fair amount of general promotion 
of our complaint number, which is 1-877-FTC-HELP, as just sort 
of general promotion for all sorts of complaints, and we 
clearly get large numbers of business opportunity complaints.
    Mr. Stearns. No, I know that.
    Mr. Beales. Simply not from franchisees. We also, a lot of 
the complaints in our data base come from other organizations. 
We have tried to negotiate complaint sharing arrangements with 
other law enforcement entities and with other regulators so 
that when, for example, for many Better Business Bureaus, if a 
complaint goes to the Better Business Bureau, that complaint 
also is automatically entered into our data base.
    So we try to reach out to get complaints. But there also 
may be, are many complaints that don't come to us or that don't 
go anywhere.
    Mr. Stearns. I think that is what happened. You know, like 
in Florida, if you sign a realtor contract for a home or you 
sign a realtor contract for renting of an apartment, there is a 
little box close to your signature that says that if you have 
any concern or questions call the Consumer Affairs of Florida, 
Department of Commerce. Do you think something like that should 
apply before you sign a franchisee agreement, that there should 
be some kind of regulation that says in the event that you are 
not happy, that we will go ahead--I mean, you can call the FTC, 
you know, just to notify the franchisee that he doesn't have to 
run to a lawyer and sue because that is what most of them want 
to do and most of these folks don't have the money to sue? So, 
you know, is it possible that you need to get the word out a 
little bit better?
    Mr. Beales. Well, in the disclosure document that is given 
to franchisees prior to the sale, there is a reference to the 
FTC that identifies us as the place to complain.
    Mr. Stearns. With a phone number. With a toll free number?
    Mr. Beales. I don't know if the phone number is there or 
not. I would have to check as to whether the disclosure 
specifically includes that.
    Mr. Stearns. There is not a specific box that they can 
focus on. It just says you can contact the Federal Trade 
Commission. Federal Trade Commission is not known to most small 
business people. Who knows where, what, what it is. For all 
intents and purposes it could be in Afghanistan. I mean they 
just don't even know. I have got here my staff showing--it says 
franchisor, Pizza Hut, Incorporated. Information for a 
prospective franchisee is required by the Federal Trade 
Commission. But it doesn't necessarily say that in the event 
that you want to complain--Okay. The Federal Trade Commission, 
Washington, DC. Okay, well, just something to think about.
    Mr. Beales. One of the things that is in the proposed rule, 
in the proposed changes is some changes in that identification 
of the FTC and, among other things, what those changes would do 
to direct prospective franchisees to our consumer education 
materials that are available both in hard copy and on our Web 
site which would presumably also help to identify us as the 
place to complain because you can, in fact, go back to that Web 
site and complain.
    Mr. Stearns. And the Federal Trade Commission is a huge 
government agency. It would be better to say the Federal Trade 
Commission, Consumer Protection, so when they call they have a 
specific number that goes right to the people and not through 
the computer operated things that says dial 3 for this and dial 
4 for that.
    Mr. Beales. Right.
    Mr. Stearns. And the GAO, the GAO in it's July 2000 report 
noted that of the 79 investigation files closed between 1997 
and 1999, only two contained notes explaining why they were 
closed, and the question is why? So----
    Mr. Beales. Well, what the practice had been, and frankly, 
as I looked at the GAO report, which was one of the first 
things I handled when I came to the FTC, I thought they had a 
good point, that we should do a better job of documenting the 
reasons that we are closing investigations. What the practice 
had been, and often is, as we develop a sweep is we may open an 
investigation of a potential target that would be part of a 
sweep of franchises and business opportunities and then refer 
that case to another enforcement partner, so that somebody else 
actually brings the case. And what we would do in this case is 
we would have opened it, but then we fairly promptly close the 
investigation. What we were not doing was documenting the 
reasons for closing or the fact of the referral, and we are 
doing that now.
    Mr. Stearns. Okay. You mentioned in your opening statement 
about most of the business deceit has been promulgated in the 
business opportunity offerings and that you are looking at 
rulemaking dealing with that. You are simply going to provide a 
more tailored disclosure rule to address business 
opportunities, I think you indicated. Given the difficulties in 
regulating and controlling business opportunity scams, 
especially today with what we have on the Internet, Internet 
based, tell me how this new rule is going to apply to fix this 
problem. You know, moving from one disclosure requirement to 
another, is that going to solve the problem? I mean, can you be 
more specific?
    Mr. Beales. Well, we do not have at this point a specific 
proposal. It is something that I have begun talking with the 
staff about, about what could we do here. I think the 
fundamental problem in business opportunities is really an 
enforcement one because we find most of the business 
opportunities that we pursue, they are covered by the Franchise 
Rule. They are not in compliance. And the question is can we 
identify specific practices that would simply make our 
enforcement job easier. I think it is harder, the strategy in 
the Franchise Rule itself, for franchisees to provide 
information. Franchisees can then avoid difficulties in many 
instances and know what they are getting into. The difficulty 
in business opportunities is the information is frequently not 
provided in the first place, even though there is an existing 
requirement to do so.
    So what we would like to do is to try to develop more 
tailored provisions, if we can, that would make the enforcement 
burden easier and make it cheaper for us to bring cases 
essentially. But there will remain an enforcement issue because 
that is the nature of the business opportunity beast in many 
cases.
    Mr. Stearns. Should Internet based business opportunity 
offerings be governed by a specific statute in the same manner 
that the franchisee-franchisor relationships of the auto and 
petroleum industries are?
    Mr. Beales. I don't think we have seen any need for that at 
this point.
    Mr. Stearns. Because you are saying its in the front end 
then. You don't think its in the post----
    Mr. Beales. Well, the problem in most of the business 
opportunity cases we bring is there is no post.
    Mr. Stearns. Right.
    Mr. Beales. It is ``take the money and run'' kind of scams.
    Mr. Stearns. Okay. Good. Yeah.
    MR. Beales. And hence we don't see a post-sale sort of 
problem in a lot of cases.
    Mr. Stearns. I see. So would you have to say yes or no to 
that question, that the Internet based--would you put a statute 
in the Internet business opportunities, a statute similar to 
the franchisee-franchisor or relationships to the auto and 
petroleum industry. Do you think yes or no to that?
    Mr. Beales. I would say no. I think the problems we have 
seen and we certainly have seen the problems of business 
opportunities promoted on the Internet, but we have been quite 
able to reach those problems under our existing authority.
    Mr. Stearns. Okay, thank you. My time has expired. Mr. 
Rush.
    Mr. Rush. Thank you, Mr. Chairman. Mr. Beales, under the 
rule are franchisors required to sign the disclosure documents 
that they provide to potential franchisees? In other words, do 
franchisors have to warrant or certify that the information in 
their disclosure documents is truthful, complete and not 
misleading?
    Mr. Beales. I think if the information is not truthful and 
complete or is misleading, that that would very clearly be a 
rule violation.
    Mr. Rush. So are they required to sign the disclosure 
documents that they provide?
    Mr. Beales. One of the things that is in the proposal would 
clarify that they can't try to waive liability for statements 
that are made in the disclosure document.
    Mr. Rush. So until--you haven't proposed the rule or the 
rule hasn't been finalized?
    Mr. Beales. That is right.
    Mr. Rush. Okay. So under the current status, are they 
required now today to sign?
    Mr. Beales. No, I don't believe they are. We think they are 
responsible and reinforce the rule that way.
    Mr. Rush. That is the way you enforce the rule?
    Mr. Beales. Yes. I mean, if there are statements made in 
the franchise disclosure documents that are not accurate, that 
is a rule violation.
    Mr. Rush. Okay, and what about being complete?
    Mr. Beales. Complete within the sense of the information 
that the rule requires to disclose, yes. If it doesn't include 
that information, that too is a rule violation and we enforce 
the rule that way.
    Mr. Rush. Does the FTC ever review or approve the 
disclosure documents it requires franchisors to give potential 
franchisees?
    Mr. Beales. We review them in particular investigations. We 
don't review them before the fact.
    Mr. Rush. Okay, so you don't approve them either?
    Mr. Beales. No. That is correct. We don't. A number of 
States do that under the Uniform Franchise Offering Circular, 
which in some States is filed and preapproved, but the FTC does 
not do that.
    Mr. Rush. Should it be permissible for a franchisor to 
state in a disclosure document that a franchise may be renewed 
even if the franchisee is required to sign a new agreement 
under different terms and conditions in order to do so?
    Mr. Beales. Well, I think what the franchisor states in the 
disclosure document must be an accurate reflection of what are 
the renewal terms of the contract. And if the renewal terms--
and you can imagine a wide range of possibilities there. If the 
renewal terms specify that you can renew this contract on these 
terms, then that is what the disclosure document better say.
    Mr. Rush. And so the fact that the contract can be renewed 
should also be explicit in the contract? Is that what you are 
saying?
    Mr. Beales. Most franchise contracts do have a renewal 
clause or renewal terms under which they can be renewed.
    Mr. Rush. Given the current resources and obligations of 
the FTC, do you think that it would be helpful for franchisees 
to have a private right of action against violators of the 
Franchise Rule?
    Mr. Beales. Well, we have not seen very often instances of 
violations of the rule that were substantive violations. We 
have brought those cases. What we have seen more often is 
narrow technical violations where we have developed a referral 
program to bring people into compliance and to avoid future 
difficulties. In many circumstances that would violate the rule 
the franchisee probably has a private right of action under the 
contract that would--because something in the disclosure 
document doesn't accurately reflect what was in the contract. 
So there may well be a private right of action there as well.
    Mr. Rush. So you don't think that should be explicit?
    Mr. Beales. No, sir, I don't. I don't. There is in 
general--under all of the FTC's rules there is not a private 
right of action or under the FTC Act itself.
    Mr. Rush. Okay. Mr. Beales, can you explain why the FTC has 
taken so long to amend this rule?
    Mr. Beales. Well, I think it has primarily been a question 
of priorities. Most of the amendments are to conform the rule 
to the Uniform Franchise Offering Circular. But the FTC has 
always recognized compliance with the UFOC as compliance with 
the Franchise Rule. So as a practical matter, people who want 
to comply that way, and as a practical matter most franchisors 
do if they are national franchisors, they already can. We ought 
to clean up the rule. We ought to conform the rule, but the 
benefits from doing so are smaller than they might be in a 
different arrangement where we didn't recognize compliance with 
the States.
    On the other hand, we persistently meet business 
opportunity frauds and that has been the place where more of 
our resources have been devoted.
    Mr. Rush. Now, I have in my possession this package, the 
chairman displayed it also, from the Pizza Hut. This is a 
disclosure packet, right?
    Mr. Beales. I don't know. I haven't seen it.
    Mr. Rush. Yes, my staff inform me that this is a disclosure 
package. It is pretty complicated. Very complicated.
    Mr. Beales. It is certainly thick.
    Mr. Rush. And encompassing. Is there any move by the FTC to 
simplify or to require a simplified process? I mean, this is--
you know, you get some family who wants to open a franchise. 
They would have to hire a law firm to really look at this stuff 
and be able to decipher and understand it. And I know it is a 
very complicated financial arrangement that the consumers or 
potential business owners are engaging in, but this is 
outrageous. You know, this is a thick, a two-inch thick package 
of information here, you know, and don't you think that the FTC 
has some responsibilities or should assume some responsibility 
for trying to simplify this so it will become less burdensome 
on the potential business owner?
    Mr. Beales. There is always a tradeoff that we meet all the 
time in consumer protection regulation between short and sweet, 
but necessarily incomplete and comprehensive. Given the amounts 
that are particularly at stake in franchise investments, both 
the amount of franchise fees and the amount of investment that 
is required, what the choice has been is to err if we do on the 
side of being complete so that franchisees have the information 
they need to make informed decisions.
    That said, part of what is at issue in the proposed rule is 
at least in some places simplifications to try to make the 
information easier for its prospective franchisees to get at--
for example, to try to make more use of graphics and charts, to 
present some of the information in a way that is more 
straightforward. I would not think it is likely to shorten that 
disclosure document very much, but hopefully it makes the 
information that is there more comprehensible.
    Mr. Rush. Let me ask you this. If you were a potential 
franchise owner with Pizza Hut, would you be able to sign this 
document without a lawyer?
    Mr. Beales. No, I would think I would want to hire a lawyer 
to help me in that kind of a relationship, and many 
franchisees, many prospective franchisees do.
    Mr. Rush. Mr. Chairman, I have just got one other question.
    Mr. Stearns. Sure.
    Mr. Rush. I am just--it just bothers me that, you know, we 
can--the FTC can say that they want to be thorough and they 
want to have complete disclosure information available and so 
therefore, you know, that this document is, this massive amount 
of documents here is appropriate. But on the other hand, the 
FTC takes 5 years, you know, to deal, to develop this rule. You 
know, it just seems to me that there is a level of 
disingenuousness there and I guess you said it wasn't a 
priority, but I would assume--I know that in my district, in my 
community that there are a lot of franchise owners, a lot of 
franchises, people who are employed by franchises. And I just 
think that the FTC, to make it--I would advise the FTC to make 
this a priority because it just seems like government is not 
caring about the problems of consumers and the problems of 
business owners, and I would also just suggest strongly that 
you all look at trying to simplify this because its just 
burdensome, intimidating, and I believe that it opens the door 
to all kinds of weird outcomes if in fact we don't get on top 
of this and get some control and corral this issue, this 
paperwork and this problem.
    Thank you, Mr. Chairman. I yield back.
    Mr. Stearns. Thank my colleague. Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. I want to follow up. 
Obviously we are in agreement up here on the panel that if we 
are looking at amendments to the 1979 rule there has been no 
amendment for 5 years. For us that is very, very unacceptable, 
so we need to move expeditiously to do that.
    Is it the case that the FTC spends only 6 percent of its 
staffs' time on Franchise Rule activities and enforcement when 
franchising, according to the GAO audit, represents over half 
of all retail sales in the United States?
    Mr. Beales. I believe it is either 6 percent or 8 percent 
of our staff resources that are devoted to franchise cases. 
So----
    Mr. Shimkus. But you don't know the percent of the overall 
sales in the United States which comes from franchise 
operations?
    Mr. Beales. No. No.
    Mr. Shimkus. But if it is more than 6 to 8 percent, 
wouldn't you say--if of course our staff is correct--if they 
are saying 50, the argument is there is probably not a direct 
proportional share of what efforts are going into this part of 
the overall economy versus other operations?
    Mr. Beales. Well, I think--I am not sure that looking at 
the fraction of sales, of retail sales, is the most useful way 
to make that comparison.
    Mr. Shimkus. But if it is 50 versus 6, there is a 
definite--I would agree with you. I mean, you know, you can use 
statistics to prove or disprove anything. But I, again, if the 
proportion is so skewed, it would make the argument that there 
probably should be more of an effort in a certain area?
    Mr. Beales. Well, I guess I would look more at complaints.
    Mr. Shimkus. Well, we are going to do that in the next 
panel. In fact, I want to follow up with a comment in the 
testimony and she will get a chance to testify in a panel, and 
I hope we have some members from the FTC that would hang around 
and listen, too. Sometimes I wish we would have complainants 
first and bureaucrats afterwards because then we could fully 
air it.
    Ms. Kezios recommends that the U.S. Department of Commerce 
collect comprehensive and accurate statistical information 
about franchising and franchise practices by, one, requiring a 
national filing of disclosure documents and, two, data 
collection and analysis.
    Do you agree with this recommendation and why or why not?
    Mr. Beales. I have not thought through that recommendation 
or explored it in any detail. I think--I mean, as a former 
academic and actually as a former academic who studies 
franchising, more information is always attractive. But there 
are burdens on the people who have to produce that information 
as well. We haven't seen a need for pre-filing or pre-approval 
of the disclosure documents in the franchise complaints or the 
franchise issues that we have seen.
    Mr. Shimkus. And previous to this last response you talked 
about a better barometer is complaints. And you have already 
admitted that the Commission received 3,680 complaints 
regarding franchises in just the period between 1993 and 1999. 
And you state that since 1979 the Commission has pursued 200 
franchise and business opportunity cases. This number, given 
the number of complaints, seems low. Why haven't we seen more 
enforcement action?
    Mr. Beales. Well,the complaints--it is a sizable number of 
complaints. It is about 2 percent of the total number of 
complaints that we get. So in terms of where our resources are 
allocated, franchising and business opportunities get a 
disproportionate share based on the number of complaints. The 
reason for that is the consumer injury in these kinds of cases 
tends to be quite high compared to what we see in a lot of 
other cases. We think there is--you know, we have tried very 
hard to leverage our resources in this area with both our 
Federal law enforcement through the Department of Justice and 
through State enforcement activities as well that gives us a 
lot more clout than that, than the 200 cases we have brought. 
In this sweep last week, for example, we brought 11 cases. The 
Justice Department brought 11 cases and there were more than 48 
cases brought by--or 48 actions, enforcement actions, brought 
by the State. So those 70 cases would show up in that statistic 
as 11 FTC cases.
    Mr. Shimkus. Mr. Chairman, if I could just finish up with 
this question.
    Mr. Stearns. Sure.
    Mr. Shimkus. Does the fact that franchisors often prohibit 
franchisees from discussing their franchise experience with 
anyone after they leave the system undermine the Franchise 
Rule?
    Mr. Beales. Well, I think the thing that would be a problem 
for the--or a potential problem for the rule is if there is 
nobody you can talk to to find out about what their experience 
was like and you didn't know that.
    Mr. Shimkus. The acronym ``let the buyer beware,'' but the 
buyer ought to be able to do research prior to going into an 
agreement. I mean, when you buy a house you can go around and 
check fair market values of like homes. You can actually talk 
to contractors and people. There are things that you can do. 
But if there is a prohibition about discussions then that would 
seem to undermine some of the ability to go into an agreement.
    Mr. Beales. Well, one of the things that is in the proposed 
changes would be----
    Mr. Shimkus. These are the amendments to the 1979 rule; is 
that the changes you are talking about?
    Mr. Beales. Yes.
    Mr. Shimkus. And will we be looking at these any time soon 
or do we still have 5 years before we receive amendments? I 
mean, it is so ridiculous to keep saying that, to tell you the 
truth. The proposed amendments which are 5 years old and we are 
proposing these to occur, can you see our frustration?
    Mr. Beales. I can. I can.
    Mr. Shimkus. So I think it probably would be incumbent upon 
the chairman and the committee to probably tie you down and say 
when will we see these. I will defer that to the chairman and, 
Mr. Chairman, I yield back my time.
    Mr. Stearns. That is a good question. You can ask it.
    Mr. Shimkus. No, go ahead.
    Mr. Stearns. When will we see these?
    Mr. Beales. We are planning to forward the staff report in 
the fall. The staff report goes out for public comment and then 
after another comment period on the staff report a final 
recommendation would be forwarded to the Commission. I haven't 
tried to figure out the time line beyond the staff report, 
which is sort of the next step in the process. Typically the 
comment period would be like 60 days and then analysis of the 
comments.
    Mr. Stearns. Okay. So maybe October you will have the staff 
report and then 60 days thereafter?
    Mr. Beales. Well, the staff report--yeah, it may be 
somewhat longer than that for the Commission to consider the 
staff report, although I think in the rulemaking process that 
is limited. Most of that consideration is after the comment 
period, not before.
    Mr. Stearns. And after the 60 days what is going to happen?
    Mr. Beales. We will analyze the comments.
    Mr. Stearns. How long will that take?
    Mr. Beales. It depends in part on how many comments we get 
and how substantive the comments are.
    Mr. Stearns. What is the general time?
    Mr. Beales. Well, it varies from, I mean I have seen--well, 
in Magnus and Moss----
    Mr. Stearns. Less than 6 months?
    Mr. Beales. It certainly can be less than 6 months.
    Mr. Stearns. Okay. So in the next year and a half we should 
see the file?
    Mr. Beales. We would be hopeful that we could meet that 
timetable.
    Mr. Stearns. Okay. Mr. Walden.
    Mr. Walden. Actually, Mr. Chairman, I have no questions at 
this time.
    Mr. Stearns. Okay, thank you. Thank you very much, Mr. 
Beales. I appreciate your coming again.
    Mr. Beales. Thank you for the opportunity.
    Mr. Stearns. And we will have the second panel now if they 
will come forward. Mr. Dale Cantone, Assistant Attorney General 
of the Maryland Securities Division; Mr. Les Wharton, Vice 
President, Legal Affairs, Franchise/License Division, Spherion; 
Ms. Susan Kezios, President of the American Franchisee 
Association; Mr. Dennis Wieczorek, Partner, at Piper Rudick, 
and he is here on behalf of the International Franchise 
Association; and last, Mr. Jerry Rizer, who is President of 
Dairy Queen Operators' Association.
    Let me thank all of you for attending this morning and we 
look forward to your testimony, and why don't we start from my 
right and go to my left. Mr. Cantone for your opening 
statement.

   STATEMENTS OF DALE E. CANTONE, ASSISTANT ATTORNEY GENERAL, 
  MARYLAND SECURITIES DIVISION; PHILLIP LESLIE WHARTON, VICE 
PRESIDENT, LEGAL AFFAIRS, FRANCHISE/LICENSE DIVISION, SPHERION; 
  SUSAN P. KEZIOS, PRESIDENT, AMERICAN FRANCHISE ASSOCIATION; 
 DENNIS E. WIECZOREK, PARTNER, PIPER RUDNICK, ON BEHALF OF THE 
     INTERNATIONAL FRANCHISE ASSOCIATION; AND JERRY RIZER, 
         PRESIDENT, DAIRY QUEEN OPERATORS' ASSOCIATION

    Mr. Cantone. Thank you, Chairman Stearns and member of the 
subcommittee. My name is Dale Cantone. I am the Deputy 
Securities Commissioner in the Office of the Maryland Attorney 
General. I also chair the Franchise and Business Opportunity 
Project Group of the North American Securities Administrators 
Association, known as NASAA, and on behalf of NASAA I 
appreciate the opportunity to appear before you today.
    As franchising continues to be an important and evolving 
business strategy in today's economy, the laws dealing with 
franchising also must evolve to protect consumers who invest in 
a franchise. Current Federal and State franchise laws require, 
among other things pre-sale disclosure. This requirement is 
intended to provide each prospective franchisee with all of the 
information necessary to make an intelligent investment 
decision before the franchisee pays any money.
    As has been recognized at the State level, 15 States have 
enacted laws regarding franchise offerings. These States 
require franchisors to prepare disclosure documents according 
to Uniform Franchise Offering Circular guidelines, called the 
UFOC. Since 1994, the FTC has accepted the UFOC as an 
alternative to the disclosure documents required under its own 
Franchise Rule. Although the UFOC is required in only 15 
States, for practical reasons many franchisors prefer the UFOC 
format. This is because the UFOC is generally considered to be 
a better disclosure document than the one required under the 
FTC's Franchise Rule and because many franchisors intend to 
sell franchises in at least one of the registration States. But 
the UFOC is not required to be used in the States without a 
separate State franchise law.
    Now, 23 years after the promulgation of the Franchise Rule, 
it is time for the FTC to update its disclosure document, the 
document that is required in all 50 States, and the logical 
model for the FTC to follow is the UFOC. The UFOC is more user 
friendly to prospective franchisees. It requires that 
disclosures be written in plain English. It also requires 
disclosure of items that are relevant in today's business 
climate; for example, issues related to computers, protected 
territory or the lack of one and use of advertising moneys.
    The Federal Trade Commission has recognized this fact and 
is currently considering a proposal to model its own Franchise 
Rule disclosure on the UFOC with some additional enhancements. 
NASAA supports this proposal. The adoption of a disclosure 
format based on the UFOC would be a significant improvement to 
the Franchise Rule.
    What is still missing at the Federal level, however, is a 
private right of action under the Franchise Rule. Without a 
private remedy injured franchisees must rely on the already 
strained resources of governmental agencies for redress. When 
those agencies are unable to take action for whatever reason, 
franchisees are unable to sue to recover losses due to 
franchise law violations. As the FTC continues its work on the 
Franchise Rule review, NASAA remains ready to offer any 
assistance that will help to ensure the prospective franchisees 
receive the most readable and material disclosure possible.
    The other issue I wish to address today relates to a type 
of investment opportunity called a business opportunity. 
Business opportunity ventures are regulated under the FTC's 
Franchise Rule, but they are clearly distinguishable from a 
franchise. Business opportunity sellers provide little, if any, 
assistance and training and exert little control over business 
opportunity buyers. The buyers generally do not operate under 
the sellers' trademark or trade name. Typical examples of 
business opportunities include vending machines, medical 
billing software programs, greeting card display racks.
    As has been recognized in the last few years, the Federal 
Trade Commission has focused its enforcement activities on 
business opportunities. The FTC reports more complaints about 
business opportunities than franchises and complaints about 
business opportunities generally involved allegations of fraud 
or misrepresentation.
    Just last week the Federal Trade Commission, the Department 
of Justice, and 17 States announced Project Busted Opportunity, 
a coordinated attack on business opportunity and work at home 
fraud. The sweep is just the latest in a series of Federal-
State initiatives regarding business opportunities. There is no 
doubt that communication and coordination between Federal and 
State officials on business opportunity issues is critical. In 
many cases, business opportunity con artists maintain offices 
in one State, but avoid selling to consumers in that State in 
an effort to avoid prosecution and detection by State 
officials.
    The FTC regularly does seek to communicate with State 
enforcement personnel in this area, through conference calls 
and e-mail, List Serve and an on-line complaint data base 
called Consumer Sentinel. For the last several years the FTC 
also has sponsored annual law enforcement summits on franchises 
and business opportunities. The summit wasn't held this year, 
but we do hope the FTC reconsiders reestablishing the summits 
in the future.
    NASAA and State business opportunity enforcement officials 
look forward to continued opportunities to coordinate with the 
FTC on enforcement actions and consumer education on both 
franchises and business opportunities. By working together we 
can be more effective in these very important areas.
    Mr. Chairman and members of the subcommittee, thank you for 
allowing NASAA to participate in this hearing.
    [The prepared statement of Dale E. Cantone follows:]
Prepared Statement of Dale E. Cantone, Deputy Securities Commissioner, 
    Chief, Franchise and Business Opportunities Unit, Office of the 
Maryland Attorney General, Securities Division, on Behalf of the North 
             American Securities Administrators Association
    Mr. Chairman and Members of the Subcommittee: My name is Dale 
Cantone. I am the Deputy Securities Commissioner in the Office of the 
Maryland Attorney General. I also chair the Franchise and Business 
Opportunity Project Group of the North American Securities 
Administrators Association (``NASAA''). In the United States, NASAA is 
the national voice of the 50 state securities agencies responsible for 
investor protection and the efficient functioning of the capital 
markets at the grassroots level. Many of the agencies that administer 
and enforce state franchise and business opportunity laws are members 
of NASAA.
    On behalf of NASAA, I appreciate the opportunity to appear before 
you today. Franchising continues to be a vibrant and popular business 
strategy in our economy. Oversight of franchising is an important 
consumer protection for hundreds of thousands of existing and 
prospective franchisees. It requires careful attention by both federal 
and state authorities. NASAA welcomes the subcommittee's interest in 
this issue and looks forward to working with you and your staffs. My 
comments today will focus on two issues: state and federal franchise 
disclosure requirements; and state and federal cooperation on business 
opportunity enforcement initiatives.
                   franchise regulation: an overview
    Oversight of franchising at the state level is grounded in the 
traditional commitment of grassroots officials to protect consumers 
whenever possible before they part with their money; and in those cases 
where money is lost in a fraudulent deal, to marshal the enforcement 
resources to shut down the violator and seek restitution if possible.
    California adopted the first state franchise statute in 1971. 
Today, 15 states 1 have statutes that regulate the offering 
of franchises for sale. Eleven of these states 2 operate 
under similar or uniform statutes that require registration with a 
state agency and delivery of disclosure documents to prospective 
franchisees prior to an offer and sale of a franchise.
---------------------------------------------------------------------------
    \1\ California, Hawaii, Illinois, Indiana, Maryland, Michigan, 
Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, 
Virginia, Washington and Wisconsin.
    \2\ California, Hawaii, Illinois, Maryland, Minnesota, New York, 
North Dakota, Rhode Island, South Dakota, Virginia and Washington. In 
addition, Oregon requires disclosure prior to the sale of franchises, 
but does not have a registration or filing process. Indiana, Michigan, 
and Wisconsin require disclosure and the filing of a ``notice of 
franchise offering.''
---------------------------------------------------------------------------
    Both state and federal franchise disclosure laws are intended to 
provide each prospective franchisee with the information necessary to 
make an intelligent decision regarding the franchise being offered. 
Further, state franchise laws bar the sale of franchises where such 
sales would lead to fraud or a likelihood that the franchisor's 
promises would not be fulfilled.
    At the federal level, the Federal Trade Commission (``FTC'') 
adopted its Franchise Rule 3 in 1979. While the FTC's 
Franchise Rule requires presale disclosure, there is no federal 
requirement that a franchisor register its disclosure document with the 
Commission, and no one at the federal level reviews the disclosure 
documents that a franchisor must provide to prospective franchisees. 
The Franchise Rule expressly preserves the right of states to adopt 
laws that are not inconsistent with the Franchise Rule if those laws 
provide protections that are equal to or greater than that provided by 
the Rule.
---------------------------------------------------------------------------
    \3\ Trade Rule 436, ``Disclosure Requirements and Prohibitions 
Concerning Franchising and Business Opportunities Ventures'' (16 CFR, 
Ch.1, Part 436).
---------------------------------------------------------------------------
    The franchise registration laws that 15 states have adopted are 
designed to provide greater protections to prospective franchisees and 
prevent fraud in the sale of franchise offerings. Eleven states require 
that franchise disclosure documents be filed and reviewed by trained 
state personnel, called franchise examiners. Through their efforts, 
state examiners can better discover proposals that are fraudulent or 
unlawful, and thereby protect state consumers before they have parted 
with their money.
    Although all states do not require registration of franchise 
offerings, few franchisors sell in non-registration states only. Thus, 
franchise reviews conducted by so-called ``registration states'' have 
improved the standard of disclosure generally in the franchise market.
    In recent years, some have questioned the need for any state to 
perform reviews of offering circulars. Yet the registration and review 
function is an important part of the franchise regulatory scheme. 
Although large franchisors typically retain experienced lawyers to 
draft franchise disclosure documents, even large franchisors sometimes 
fail to disclose all of the information required by the disclosure 
guidelines. In addition, some large franchisors target unsophisticated 
franchisees. The franchise review process can better inform the 
unsophisticated franchisee about risks the franchisee may not fully 
appreciate. The states' ability to require financially undercapitalized 
franchisors to escrow franchise fees also benefits prospective 
franchisees. State examiners may identify specific ``risk factors'' 
that a franchisor must disclose on the cover of state disclosure 
documents. These risk factors highlight special concerns that a 
franchisee should consider before investing in a franchise.
    In addition, not all franchisors are well established or 
experienced in preparing offering circulars. States routinely receive 
franchise registration applications from start-up and smaller franchise 
systems. Some of these applications are prepared without benefit of 
legal counsel. Some do not even begin to approach substantial 
compliance with the state guidelines. For these franchisors and, more 
important, for their prospective franchisees, the review function 
conveys a critical benefit.
    State agencies that require filing of franchise disclosure 
documents also serve as an important repository of information for 
prospective franchisees to compare documents from various franchisors. 
In many instances, this information is crucial to the process 
undertaken by investors to evaluate franchise deals. Many franchisors 
do not deliver copies of their disclosure documents to the public upon 
request.
    The states have a broad assortment of enforcement tools available 
under their franchise laws that allow them to move swiftly and 
decisively against violators. States may issue orders prohibiting 
violations of the law, as well as orders denying, suspending and 
revoking registration and exemption of franchises. In addition, states 
have injunctive and criminal referral authority.
    Franchisees in registration states benefit tremendously from the 
private right of action granted under state law. In contrast, private 
parties cannot enforce violations of the FTC Rule; only the FTC has 
that authority. A private right of action allows consumers to sue for 
damages when they sustain losses due to franchise law violations. The 
experience of state regulators is that private remedies serve as a 
necessary supplement to governmental regulation and enforcement efforts 
in providing a deterrence to abuse. Without private remedies, injured 
franchisees can be protected only through governmental action. The 
absence of a private remedy places a greater premium and demand on the 
already strained resources of the regulatory agencies and frequently 
means that fewer injured franchisees can be ``made whole'' than would 
be the case if a private right of action was explicitly authorized in 
the law.
                           the role of nasaa
    An important goal of NASAA is the promotion of efficient and 
uniform state laws. In the franchise regulation area, it is NASAA's 
intention to move forward and continue the serious efforts the 
Association has undertaken to promote uniformity of state law, provide 
enhanced training and educational opportunities for state franchise 
personnel, seek ever more cooperative relationships with the Federal 
Trade Commission, and solicit the advice and input of franchisors and 
franchisees.
    To further the goal of state uniformity, NASAA authored and 
encouraged adoption of the UFOC Guidelines. NASAA sponsors regular 
franchise training programs and educational seminars for state 
franchise examiners. NASAA also regularly proposes uniform statements 
of policy on many franchise related issues. These statements of policy 
are model laws and regulations that are made available for states to 
adopt in accordance with their laws. NASAA recently implemented a new 
Internet ``List Serve'' by which state examiners and enforcement 
personnel can contact each other to discuss issues of common concern 
and seek effective solutions to matters involving franchise reviews and 
potential enforcement actions.
    Two years ago, NASAA developed and launched a new program of 
coordinated franchise review, which has been adopted by all of the 
franchise registration states except California. Coordinated franchise 
is a voluntary program open to franchisors that allows them to file a 
franchise registration in multiple states at the same time. Coordinated 
review eliminates conflicting comments by state examiners and results 
in a single, uniform franchise offering circular that is made effective 
on the same date in multiple jurisdictions.
           the uniform franchise offering circular guidelines
    NASAA authored the Uniform Franchise Offering Circular (``UFOC'') 
Guidelines after holding public hearings and extensive discussion with 
members of the franchisor and franchisee communities, academics, and 
the FTC. On April 25, 1993, NASAA unanimously adopted the UFOC 
Guidelines as the recommended format for franchise disclosure documents 
at the state level. Within two years, the new Guidelines were adopted 
by each of the state franchise regulatory authorities that require 
registration of franchise offerings. On December 30, 1993, the FTC 
approved the use of the UFOC as an alternative to the FTC's disclosure 
requirements.
    As part of its ongoing Rule Review, the FTC is currently 
considering a proposal to replace the franchise disclosure requirements 
4 under the Franchise Rule with updated disclosure 
requirements based in large part on the UFOC Guidelines, with some 
additional disclosures. NASAA supports the FTC's efforts to modify the 
Franchise Rule in this way.
---------------------------------------------------------------------------
    \4\ Described at 16 CFR Sec. 436 (a) (1) through (20).
---------------------------------------------------------------------------
    The UFOC is the only franchise disclosure document that franchisors 
may use in the 15 states that register franchise offerings. The UFOC 
Guidelines are, in fact, a revision of several earlier versions of the 
Guidelines, versions of which have been in effect since 1975. The UFOC 
Guidelines reflect an effort on the part of NASAA to produce a more 
readable and relevant disclosure document for franchisees, and one that 
does not unduly burden franchisors. It is a disclosure document that 
was based on the experiences of many individuals in the franchise 
community as to what constitutes ``material'' information about a 
franchise offering.
    NASAA asserts that the UFOC is a superior disclosure document than 
the current disclosure document required under the Franchise Rule. The 
UFOC requires disclosure of information that franchisees need to know 
in order to make an informed investment decision in the present 
business environment. For example, the UFOC requires disclosure of 
required computer hardware and software (UFOC Guidelines, Item 8 A), 
including whether the franchisor will have independent access to the 
stored data (UFOC Guidelines, UFOC Guidelines, Item 11, Instruction 11 
iii c). The UFOC Guidelines require extensive disclosure about a 
franchisor's use of advertising dollars and advertising programs (UFOC 
Item 11). There is extensive disclosure about protected territory, or 
the lack of one, and the franchisor's ability to establish alternative 
channels of distribution in a protected territory (UFOC Item 12). The 
UFOC is intended to be written in ``plain English'' (UFOC Instruction 
150) and features a readable cover page that emphasizes the most 
important aspects of the disclosures in the document.
    There would be a significant advantage to franchisors if the FTC 
were to adopt a new Franchise Rule based on the UFOC model. Many 
franchisors, especially those that offer franchises in multiple 
jurisdictions, have experience with preparing an offering circular 
based on the UFOC Guidelines. The Guidelines are intended to produce a 
single disclosure document that may be used in multiple states. In 
addition, many of the questions of interpretation that inevitably 
accompany any new guideline or regulation have been answered. The UFOC 
Guidelines have been the subject of numerous programs and seminars open 
to franchisors and franchisees. In 1994 and 1998, NASAA published 
Commentaries to the UFOC designed to discuss and clarify issues of 
interpretation.
    As part of the FTC's recent Franchise Rule Review, the FTC has 
sought input from NASAA and a variety of other sources representing 
both franchisors and franchisees. In addition, the FTC has sought to 
work with NASAA and the franchise review states to ensure that the new 
disclosure document to be required under the Franchise Rule provides 
enhanced and commonsense disclosures for franchisees. As a result, the 
FTC has identified several disclosure items not currently required 
under the UFOC Guidelines that the FTC may seek to require under the 
revised Franchise Rule, for example, new disclosures related to a 
franchisor's parent and franchisor initiated litigation.
    The disclosure document that the FTC has proposed under its Rule 
Review is a significant improvement over the existing format. Adoption 
of a federal franchise disclosure document consistent with the current 
proposal would benefit prospective franchisees in every state, 
especially those who reside in the 35 states that do not currently 
require a disclosure document to be prepared under the UFOC Guidelines. 
NASAA and the franchise review states look forward to continuing to 
work with the FTC as it seeks to finalize the new Franchise Rule.
 distinguishing between disclosures for business opportunities and for 
                               franchises
    One of the other proposals in the FTC's Franchise Rule Review is to 
include a specific definition of ``business opportunity'' that 
distinguishes it from a ``franchise.'' NASAA applauds this effort. This 
distinction is necessary in order to avoid the current confusion caused 
by the FTC's attempts to regulate two distinct types of business 
enterprises under one rule. Typical ``business opportunities'' include 
distributorships involving vending machine, greeting card display 
racks, and medical billing software.
    Currently, 24 states regulate the offer and sale of ``business 
opportunities.'' Many states require registration of business 
opportunity sellers as well as presale disclosure to prospective 
buyers. In general, states require business opportunity sellers to 
provide a disclosure document that, in most cases, is simpler and more 
abbreviated than the type of disclosure document required for franchise 
offerings.
    Most business opportunity ventures are clearly distinguishable from 
a franchise. Business opportunities generally require much smaller 
investments than the fees required to purchase a franchise and unlike 
franchisors, business opportunity sellers provide very little, if any, 
assistance and training and exert little control over business 
opportunity purchasers. The contracts are simpler and impose fewer 
restrictions on buyers. In addition, business opportunity buyers 
generally do not operate under the sellers' tradename, trademark, or 
service mark. The creation of a separate definition of a business 
opportunity under the Franchise Rule would recognize these differences.
    A separate definition for business opportunities also would improve 
state and federal enforcement efforts. Prospective business opportunity 
buyers have expressed their concern and confusion over the type of 
investment being purchased. For example, a business opportunity under 
state law might be considered a franchise under the Franchise Rule. 
Adopting a clear and distinct definition of a business opportunity 
would enable prospective buyers to determine what rules apply--to their 
investments. This revision also would benefit state and federal 
enforcement efforts by clearly defining the type of investment 
opportunity being investigated.
   federal and state cooperation on business opportunity enforcement 
                                actions
    On June 20, 2002, the FTC, Department of Justice (``DOJ'') and 17 
states announced ``Project Busted Opportunity,'' a coordinated attack 
on business opportunity and workathome fraud. The initiative included a 
consumer education campaign and a law enforcement sting targeting 
hucksters who use deceptive earnings claims and paid ``shills'' to 
promote their scams or otherwise violate consumer protection laws. 
Seventyseven operations were caught in the sting.
    The 17 state law enforcement agencies participating in Project 
Busted Opportunity announced a total of 48 actions against business 
opportunity sellers. Those actions include lawsuits, cease and desist 
orders, consent agreements, and fines. The FTC and DOJ each brought 11 
cases in federal court.
    Project Busted Opportunity is but the latest in a series of 
federal/state enforcement sweeps regarding business opportunity fraud. 
Since 1995, the FTC has organized at least six federal/state 
coordinated sweeps aimed primarily at business 
opportunities.5
---------------------------------------------------------------------------
    \5\ See United States General Accounting Office, Federal Trade 
Commission Enforcement of the Franchise Rule: Report to Congressional 
Requesters; Table 7, p. 66 (July 2001).
---------------------------------------------------------------------------
    From about 1995 until 2001, the FTC and NASAA have jointly 
sponsored annual law enforcement summits dealing with business 
opportunities, franchises and pyramid schemes. These summits presented 
an opportunity for state and federal law enforcement officials to 
communicate with each other and coordinate law enforcement issues. At 
the summits, state and federal law enforcement personnel had the 
opportunity to meet and discuss current and anticipated enforcement 
actions, upcoming sweeps, industry trends, investigative techniques, 
and consumer education. Last year, the FTC did not hold an annual law 
enforcement summit on franchises or business opportunities. NASAA hopes 
that, in the future, the FTC will join us again in co-sponsoring these 
important events.
    FTC staff also regularly communicates with state enforcement 
personnel through regular conference calls, an FTC sponsored business 
opportunity List Serve, and Consumer Sentinel. Consumer Sentinel is an 
on-line complaint database repository available to approximately 250 
law enforcement agencies around the U.S., Canada and beyond. The 
Consumer Sentinel database is a valuable resource, and has proven 
itself to be an especially effective tool in the fight against business 
opportunity fraud.
    There is no doubt that communication between federal and state 
officials on business opportunity issues is critical. In many cases, 
business opportunity con artists maintain their offices in one state 
but avoid selling to consumers in that state, in an effort to avoid 
detection and prosecution by state law enforcement officials. In those 
instances, it is critical for states to work with each other and 
federal officials to make sure that the business opportunity con 
artists are identified, caught and brought to justice.
    NASAA and state business opportunity enforcement officials look 
forward to continued opportunities to work with the FTC and each other 
to take effective action against con artists who commit business 
opportunity fraud. We hope to continue and expand interagency 
opportunities to work together on both enforcement matters and consumer 
education.
                               conclusion
    Mr. Chairman and members of the Subcommittee, NASAA appreciates 
your interest in franchising and the role of the states in safeguarding 
the interests of franchisees. It should be apparent that the current 
system of state franchise regulation is a vital component of the entire 
regulatory scheme in this area. Clearly, oversight of franchise and 
business opportunity offerings is an important consumer protection for 
the hundreds of thousands of people who invest in these operations. We 
look forward to a continuation of federal and state cooperation on 
franchising and business opportunity issues.
    Thank you.

    Mr. Stearns. Thank you. Mr. Wharton.

               STATEMENT OF PHILLIP LESLIE WHARTON

    Mr. Wharton. Good morning, Mr. Chairman, members of the 
subcommittee. Thank you for inviting me today to discuss the 
FTC Franchise Rule. My name is Les Wharton. I am the Vice 
President of Legal Affairs for the Franchise/License Division 
of Spherion Corporation.
    Spherion is a staffing company founded in 1946. We are 
headquartered in Fort Lauderdale, Florida, and operate a 
network of approximately 940 locations primarily in North 
America. Our stock is publicly traded on the New York Stock 
Exchange. We were created in the merger of two large staffing 
companies in 1999, Norrel and Interim Services. Spherion has 
been franchising since 1956. I chair the International 
Franchise Association's Corporate Counsel Committee, and I am 
also the vice chair of the Legal Legislative Committee of that 
organization. I have been involved in franchising since 1981.
    I believe that the Federal and State pre-sale disclosure 
process is critically important in providing a framework within 
which small business franchise investors can evaluate franchise 
investment opportunities. At Spherion we want our franchisees 
to be fully aware of how our business operates before they 
become franchisees. We also want our franchisees to understand 
how a franchise relationship is structured and what our 
respective obligations are during the course of the 
relationship.
    Preparation of a disclosure document takes substantial time 
and effort and is expensive. But pre-sale disclosure, the pre-
sale disclosure process is good for franchise investors and for 
franchise systems. It provides the basis for both parties to 
consider whether they want to do business with each other.
    We want our franchisees to make a commitment to our brand 
and our way of doing business, and the only way that they can 
do that is if they are fully informed about what we do and the 
way that we do it. We don't want any surprises about what is 
expected of us after the relationship begins, and neither do 
our franchisees.
    It is not in our short-term or long-term interest to expand 
our business with franchisees unless they are fully aware of 
our operating standards and business philosophy, and it is not 
in their short-term or long-term interest to make an investment 
with us unless they understand and embrace our business 
concept. The pre-sale disclosure process protects both 
franchisees and franchisors and creates a business climate in 
which franchising has flourished.
    I am very encouraged about the FTC current effort to revise 
and modernize its Franchise Rule. There are a number of 
proposed revisions that will be particularly important, but I 
would like to take a moment to discuss four of the proposed 
revisions.
    First, we believe that the proposal to replace the current 
FTC rule format with the Uniform Franchise Offering Circular 
format, developed by State franchise regulators, is a very 
positive step. This will eliminate inconsistency between 
disclosure documents provided to franchise investors.
    Second, I believe it is important that the FTC develop 
separate disclosure rules for franchises and business 
opportunities. Franchise investments are so distinct from 
business opportunities that each should have and must have its 
own rule.
    Third, I agree with the FTC's recommendation not to require 
a mandatory earnings claim. A uniform, ``one size fits all'' 
approach to disclosing earnings information will not work. Our 
business operations are significantly different from the 
operations of other franchised businesses in other industries. 
It makes no sense to require all franchised businesses, 
regardless of the industry in which they operate, to provide 
earnings information on a uniform basis. I believe that the 
best way for the franchise investor to evaluate the potential 
from a franchise business is, one, to thoroughly review the 
franchise disclosure document; two, to get professional legal 
and financial assistance in that review; and, most importantly, 
to talk with as many current and former franchisees as possible 
before making that development. It is important to note here 
that a list of the names and addresses and phone numbers of the 
current franchisees as well as those who have left the system 
within the last year is required by the rule to be part of the 
disclosure document.
    Fourth, I support the FTC's efforts to modernize the rule 
in order to permit an electronic disclosure. At the time it was 
promulgated we didn't even have fax machines. Now we have e-
mail Web sites. It has significantly altered the way that we do 
business.
    I believe that the FTC has created a thorough and 
comprehensive record on which to move forward in its 
rulemaking, and I believe that as a result the forthcoming 
revisions to the rule will receive wide support from interested 
parties.
    In closing, let me reiterate my support for the pre-sale 
disclosure process and emphasize the great benefits of pre-sale 
disclosure for both the franchisees and the franchisors. 
Franchising is founded on open and honest relationships, and on 
realistic expectations about the franchise business. There is 
no better way to ensure a mutually successful franchise 
business enterprise than for both parties to enter into the 
business fully aware of what their mutual rights and 
obligations are.
    Thank you.
    [The prepared statement of Phillip Leslie Wharton follows:]
  Prepared Statement of Phillip Leslie Wharton, Vice President, Legal 
       Affairs, Franchise/License Division, Spherion Corporation
    Good morning.
    Mr. Chairman and members of the Subcommittee thank you for inviting 
me to appear today to discuss ``The FTC Franchise Rule: Twenty-Three 
Years After Its Promulgation.''
    My name is Les Wharton. I am the Vice President, Legal Affairs, for 
the Franchise/License Division of--Spherion Corporation (``Spherion'').
    Spherion is a staffing company that delivers performance-enhancing 
solutions to businesses in recruitment, technology and outsourcing 
services. Founded in 1946, Spherion is headquartered in Ft. Lauderdale, 
Florida and operates a network of approximately 940 locations primarily 
in North America, and includes operations in Europe and Australia/Asia. 
Its stock is publicly traded on the New York Stock Exchange. Spherion's 
revenues last year were $2.7 billion.
    Spherion operates its clerical and light industrial staffing 
business through 372 company owned and 246 franchised locations. It has 
been franchising that business since 1956.
    I am also Chairman of the International Franchise Association's 
Corporate Counsel Committee, a committee of approximately 60 in-house 
franchise counsel, and Vice-Chair of the Legal/Legislative committee of 
the International Franchise Association. I have been involved in 
franchising since 1981. I am a member of the American Bar Association 
(the ``ABA'') Forum on Franchising and I have served for some time as a 
member of the Steering Committee of the Forum's Corporate Counsel 
Division. I am also a member of the Franchise Committee of the 
International Bar Association. I have been a speaker on franchise 
topics at IFA meetings and Legal Symposia, and at the ABA Annual 
Meeting as well as at the Forum on Franchising Annual Meeting.
    It is a pleasure to be here to discuss this important topic. I 
believe that the federal and state pre-sale disclosure process is 
critically important in providing a framework within which small 
business franchise investors can evaluate franchise investment 
opportunities. At Spherion, we want our franchisees to be fully aware 
of how our business operates before they become franchisees. We also 
want our franchisees to understand how our franchise relationship is 
structured and what our respective obligations are during the course of 
the relationship.
    The presale disclosure process is good for franchise investors and 
for franchise systems, because it provides the basis for both parties 
to consider whether they want to do business with the other. We want 
our franchisees to make a commitment to our brand and our way of doing 
business, and the only way they can do that is if they are fully 
informed about what we do and why we do it. We don't want any surprises 
about what is expected of us after the relationship begins, and neither 
do our franchisees.
    It is not in our short or long term interest to expand our business 
with franchisees unless they are fully aware of our operating standards 
and business philosophy. And it's not in their short or long term 
interest to make an investment with us unless they understand, and 
embrace, our business concept. The presale disclosure process protects 
both franchisees and franchisors, and creates a business climate in 
which franchising has flourished.
    I am very encouraged about the FTC's current effort to revise and 
modernize its Franchise Rule. There are a number of proposed revisions 
to the Rule that will be particularly beneficial to Spherion. I would 
like to take a moment to mention several of those proposed revisions.
    First, we believe that the proposal to replace the current FTC Rule 
format with the Uniform Franchise Offering Circular format developed by 
state franchise regulators is a very positive step. The UFOC was 
updated several years ago, and unlike the FTC Rule is accepted in all 
states that have adopted state franchise laws. For a company like 
Spherion, with operations all across the U.S., the harmonization of the 
federal and state disclosure formats will be a significant improvement. 
This will eliminate any inconsistency between disclosure documents 
provided to franchise investors and create greater consistency for 
anyone considering a franchise investment.
    Second, I believe that it is important that the FTC develop 
separate disclosure rules for franchises and business opportunities. 
Franchise investments are sufficiently distinct from business 
opportunities that each should have its own rule. In addition, because 
the vast majority of complaints alleging violations of the FTC Rule 
involve business opportunities and not franchises, separate rules would 
result in greater accuracy in categorizing complaints and obtaining 
relief for investors.
    Third, I agree with the FTC's recommendation not to require 
mandatory earnings claims. A uniform, one-size-fits-all approach to 
disclosing earnings information will not work. Spherion's business 
operations are significantly different from the operations of other 
franchised businesses in other industries. It makes no sense to require 
all franchised businesses, regardless of the industry in which they 
operate, to provide earnings information on a uniform basis.
    Further, since we do not maintain the books of our franchisees, it 
would be virtually impossible for us to ascertain the validity of any 
cost information that they provided us to use in making such earnings 
claims. As a result, franchise investors would receive information that 
we could not verify and which could be less than accurate.
    I believe that the best way for a franchise investor to evaluate 
the potential earnings from a franchised business is to obtain and 
thoroughly review the franchise disclosure document, retain 
professional legal and financial assistance in that review and most 
importantly, to talk to as many current and former franchisees as 
possible before making the investment. A list of our franchisees, 
including addresses and telephone numbers, is included in the 
disclosure document.
    Finally, I would like to indicate support for the FTC's efforts to 
modernize the Rule in order to permit electronic disclosure. At the 
time the FTC Rule was promulgated, we didn't even have fax machines. 
Now we have email and websites that have significantly altered the way 
in which we do business. I believe that the FTC's efforts in this area 
are critical, as electronic communication has the potential to provide 
greater, more readily available information to franchise investors 
while simultaneously reducing costs both to franchisors and 
franchisees.
    There are other proposed changes to the FTC Rule in which I have an 
interest, but I wanted to highlight these four because of their 
importance to Spherion as well as the rest of the franchise community. 
I believe that the FTC has created a thorough and comprehensive record 
on which to move forward with its rulemaking, and believe that as a 
result the forthcoming revisions to the Rule will receive wide support 
from all interested parties.
    In closing, let me reiterate my support for the presale disclosure 
process and emphasize the great benefits of presale disclosure for both 
franchisees and franchisors. Franchising is founded on open and honest 
relationships, and on realistic expectations about the franchised 
business. There is no better way to ensure a mutually successful 
franchise enterprise than for both parties to enter into the business 
fully aware of their mutual rights and obligations to make the business 
a success.
    Thank you again for taking the time to discuss this important 
subject, and for inviting me here to appear today.
    Good morning.

    Mr. Stearns. I thank the gentleman.
    Ms. Kezios.

                  STATEMENT OF SUSAN P. KEZIOS

    Ms. Kezios. Mr. Chairman, my name is Susan Kezios, 
president of the American Franchisee Association. The 
Franchisee Association is made up of the small businesspeople 
who buy the franchises from the corporate franchisors like Mr. 
Wharton's company.
    We are here because 23 years after the promulgation of the 
FTC rule, my franchisees, my members have big problems. They 
have got big problems postsale because of what happens and what 
doesn't happen in the presale process. We estimate that our 
members, 15,000 of our AFA members in the aggregate, we have 
about $7.5 billion in sunk costs in their businesses.
    So these are the men and women, the families who buy the 
franchises, who invest their money, and who work the 
businesses. Like everybody else here, we are all for full and 
complete disclosure; however, under the current scheme, I am 
here to tell you that that is an impossibility.
    There is some important background that you should know. 
The FTC's Franchise Rule was promulgated in 1979 based on 
1960's market conditions. So it was designed to address the 
dysfunctions of what was going on in franchising in the 1960's, 
and in the 1960's the scam in franchising was in the presale 
process. The scam in franchising today is not in the presale, 
it is in the contract.
    During those days, the 1960's into the 1970's, when the 
FTC's rule was being debated, certain corporate franchisor 
lawyers worked to hobble the promulgation of the rule. When the 
rule's promulgation was inevitable, they worked then to weaken 
its effectiveness. That is where we are today. We have a weak 
rule with even weaker enforcement.
    Our members have little faith in the FTC. They have little 
faith in the FTC's enforcement of the rule for three reasons. 
One, as has already been mentioned by a member of this 
subcommittee, the disclosure documents are written to 
circumvent the existing rule. Any franchisor--corporate 
franchisor lawyer worth his or her salt can write a disclosure 
document that will meet the minimum requirements of the FTC's 
rule.
    Second, the franchise contracts that the franchisees sign 
actually deprive small business owners of many basic legal 
rights, common law rights. Someone surmised earlier that I am 
sure we can go and bring a private right of action. No. In 
fact, in many contracts you waive your right to a jury trial in 
order to become a franchise owner of XYZ Company.
    And No. 3, corporate franchisor lawyers write the contacts 
in such a way that the contracts can change after you sign. 
They become a moving target, and for somebody whose investment 
is sunk into the business, they can't move anywhere, they have 
to deal with that contract afterwards.
    When our members enter into franchise contracts and into 
the franchise business relationship, they do so with the intent 
of dealing with their franchisor in good faith. Franchisors 
today are even teaching each other--the corporate franchisor 
lawyers are teaching each other how to draft contracts to 
negate the duty of good faith. That is something that I will 
submit to the committee that came to our attention recently.
    So you need a fleet of attorneys to begin with to 
understand that 2-inch-thick disclosure document. And as Mr. 
Rush pointed out, how many families are going to invest in the 
time and invest in the lawyers to do that?
    Now, in my written statement, we talk about two areas that 
the subcommittee can take a look at. Mr. Shimkus pointed out 
one of them is--one of our recommendations is that some Federal 
agency has to collect data on franchising. No Federal agency 
has collected data on franchising since 1988. That is when the 
U.S. Department of Commerce ceased its collection of franchise 
data. And no branch of the Federal Government has ever been a 
Federal repository for those documents.
    Our second recommendation, as in my written statement, is 
that we would recommend the FTC to require corporate 
franchisors to disclose historical financial performance 
information, what Mr. Wharton is calling income claims here, to 
prospective franchisees. Let me emphasize historical financial 
performance information. We are not talking about what you 
might do, projected earnings. Franchisors routinely receive 
this information from their small business franchisees in 
monthly, weekly, sometimes daily accounting requirements.And 
there is no Federal rule, there is no State law that prohibits 
disclosure of historical financial performance information. 
This is a totally voluntary disclosure in the FTC rule, and 
most franchisors simply volunteer not to disclose it. And what 
is most ironic about this historical performance information, 
99.9 percent of the cases that the FTC took up against 
franchisors involved misleading or misrepresented earnings 
information to the prospective buyer.
    Now, our members also feel that the FTC staff incorrectly 
believes their authority does not extend to postsale franchise 
relationships, and as has already been pointed out, the GAO's 
audit brought some interesting data of its own. Franchise 
complaints have increased tenfold. Over 90 percent of those 
complaints have to deal with postsale problems or a combination 
of pre- and postsale problems.
    I mean, what more evidence do you need that the Federal 
Trade Commission is asleep at the wheel when it comes to what 
are the real problems out there for franchisees?
    We believe that franchising has grown significantly from 
the 1960's, from its infancy. It then may have been a method of 
distribution. It has evolved into a powerful industry, a 
largely self-regulated interstate commerce industry. We would 
urge members of this panel to consider our point of view. The 
relationship between the franchisors, the corporate 
franchisors, and the small business franchisees has suffered 
from benign neglect for too long, and hopefully this 
subcommittee will begin a new debate on the appropriate 
guidelines for or future. Thank you.
    [The prepared statement of Susan P. Kezios follows:]
 Prepared Statement of Susan P. Kezios, President, American Franchisee 
                              Association
    Chairman Stearns and Members of the Subcommittee: My name is Susan 
P. Kezios. I am the President of the American Franchisee Association 
(AFA). The American Franchisee Association was founded in February 1993 
and is the largest trade association of small business franchisees in 
the United States. We strive in every way possible to promote a 
business-to-business relationship predicated upon good faith and fair 
dealing because we represent the people who invest in franchised 
businesses and who actually work in them. The entrepreneurial men, 
women and families who make up our fifteen thousand AFA members own 
over 30,000 franchised outlets in 60 different franchise systems. In 
the aggregate, we estimate our members have invested, excluding real 
estate, more than $7.5 billion in sunk costs to build the brand names 
of their franchise systems.
    We are grateful for this opportunity to present our views on the 
activities of the Federal Trade Commission (FTC) in its enforcement of 
its Trade Regulation Rule on Disclosure Requirements and Prohibitions 
Concerning Franchising and Business Opportunity Ventures (16 CFR part 
436) (aka, ``Franchise Rule,'' ``the Rule,'' or the ``FTC's Franchise 
Rule'') because it is our membership, and other would-be small business 
franchisees that the Rule was intended to inform in the first place. 
Like our counter-parts, the AFA welcomes and supports full pre-sale 
disclosure as a means to improve and grow franchising.
    The AFA and its members have been active in responding to both the 
Commission's Advanced Notice of Proposed Rulemaking (ANPR) and Notice 
of Proposed Rulemaking (NPR). In addition, we actively participated in 
each of the FTC's series of public workshop conferences held in 1995, 
1996 and 1997. All of the AFA's extensive suggestions for improvements 
to the Rule and of the FTC's role in enforcing the Rule have already 
been put in writing to the Commission. Copies of those suggestions are 
attached to my testimony.
    The FTC's Franchise Rule was promulgated in 1979 based on 1960's 
market conditions. It was crafted to address the dysfunctions of 
franchising during the 1960's when franchising was in its infancy. 
Certain franchisors and their lawyers worked in those days to hobble 
promulgation of the Rule. Change often comes slowly, and at that time, 
they fought the Rule like tobacco companies fought the health warning 
labeling of cigarettes and automakers fought seat belts. When they 
couldn't stop the Rule's promulgation they worked to weaken its 
effectiveness. The end result is that twenty-three years later we have 
a weak rule with even weaker enforcement. That being said, I would like 
the Subcommittee to consider directing the FTC to take action in three 
areas that would give the franchise investor more useful, accurate and 
complete information in order to make an informed decision. First, we 
ask that the Subcommittee direct the FTC to change the language on the 
front cover page now required by the FTC to be affixed to each 
disclosure document. This cover page reads in part, ``To protect you, 
we've required your franchisor to give you this information. We haven't 
checked it and don't know if it's correct.'' The cover page then 
deputizes the prospective franchisee by concluding with, ``If you find 
anything you think may be wrong or anything important that's been left 
out you should let us know about it. It may be against the law.''
    The FTC's cover page gives two distinct but misleading impressions 
to the purchaser of a franchise; first that the ``government'' is 
somehow involved in the sale of franchises and is watching out for the 
investor's interests and second, that if the purchaser finds anything 
wrong, that the government would actually do something about it. That's 
the hollow invitation presented by the FTC cover page. It's an empty 
invitation because the available data shows they are simply not going 
to do anything about the majority of franchise complaints presented to 
them. Franchisors know that the FTC cover page warning carries very 
little weight; they attach it to their disclosure documents with a wink 
and a nod, knowing that it helps them overcome a prospective 
franchisee's hesitancy.
    The second area on which we would like the Subcommittee to focus 
its efforts has to do with the collection of data. No branch of the 
federal government has collected data on franchising since the U.S. 
Department of Commerce ceased its collection of franchise data in 1988. 
And no branch of the federal government has ever been a central 
repository for the offering circulars prepared by franchisors.
    We recommend that the Subcommittee require the FTC to direct 
franchisors to file their offering circulars a minimum of annually with 
the Commission. The means are readily available for these documents to 
be filed electronically and made available to the public at a modest 
cost. This would facilitate the kind of comparison shopping for 
franchise opportunities the Rule was originally designed to foster.
    The Subcommittee has been provided with copies of at least two 
different offering circulars (Domino's and Pizza Hut) to serve as 
examples and I would invite Members to thumb through those yellow-page 
sized documents. Despite the magnitude of even just the initial 
investment required by the small business man or woman interested in 
becoming a franchisee, there is no signature of any franchisor officer 
anywhere to be found on the circulars. Given the current Enron-inspired 
plummet in investor confidence, perhaps another reform would be an FTC 
requirement for corporate validation of franchise offerings.
    We also recommend that the Subcommittee require the FTC to compile, 
analyze and publish statistical information on franchise business 
ownership and performance and on national franchise practices. These 
reports could finally begin to create a body of comprehensive, 
objective and accurate information about the operation of franchise 
systems and franchised businesses.
    Third, we recommend that the Subcommittee direct the FTC to require 
that franchisors provide historical financial performance data in the 
disclosure documents they are required to provide to prospective 
franchisees. Let me emphasize historical financial data, not 
prospective or future anticipated financial estimates. If providing 
pre-sale information is important, then it is a fatal flaw of the FTC's 
Franchise Rule that disclosure of some measure of financial performance 
is not required. The fiction that franchisees can and should buy a 
franchise without receiving this most elementary data is well outside 
the norm in commercial practices. It is inherently misleading (by 
omission) not to disclose historical financial performance information.
    A major problem in the go-go 1960's, when franchising was beginning 
to roar out of its infancy, was those folks selling franchises and 
promising investors they would make specific large amounts of money if 
only they bought a particular franchise. You see, corporate franchisors 
collect royalties from their outlet owners on sales, not profits, so it 
is in the franchisor's best interest to have risk-taking franchisees 
open as many outlets as possible. The FTC's requirements regarding 
``earnings claims'' (Item 19 in the offering circular) were born out of 
that era.
    Twenty-three years after its promulgation, franchisors hide behind 
and misuse the Item 19 disclosure requirement of the Franchise Rule. 
Prospective buyers are told by franchise salespeople that they are 
``prohibited by law'' from making any earnings representations. There 
is no federal rule or state law that prohibits franchisors from 
providing accurate earnings information in the disclosure document. 
Providing earnings claims is a voluntary disclosure that the majority 
of franchisors, by at least tacit agreement among them, volunteer not 
to make.
    What is most ironic about the voluntary disclosure of earnings 
claims is that of the franchise enforcement cases undertaken by the FTC 
during the time period studied in both the GAO's July 1993 and 2001 
Reports, 99.9% of the cases cited had to do with fraudulent or 
misleading earnings information. Yet, surprisingly, the FTC does not 
think the American consumer is entitled to that information.
    The worst part about franchisors' not providing historical 
financial performance information is that those of us in the industry 
know that the information is being given out all the time. Moreover, 
this information is readily available to franchisors as they require 
franchisees to provide this data to them as part of routine financial 
reporting under the franchise agreement. We need to make it mandatory 
and we need to make it reliable.
    Finally, it is clear to our members, based on the General 
Accounting Office's (GAO) July 2001 audit of the FTC's enforcement of 
the Franchise Rule that FTC staff believe, incorrectly, that their 
authority does not extend to post-sale franchise relationship matters. 
Regardless, the GAO audit itself provided some interesting data 
including the fact that franchise complaints to the FTC in general 
increased ten-fold during the time period studied. Also that 92% of the 
franchise complaints that come to the FTC have to do with post-sale 
franchise relationship problems (or a combination of pre- and post-sale 
problems).
    The GAO's 2001 audit did not conclude that there are not franchise 
relationship problems, but rather only that there is no data on the 
extent of franchise relationship problems. Relationship problems often 
occur because of the zealousness of franchisor lawyers who draft the 
contracts on behalf of their clients. A variety of clauses are added to 
franchise contracts to provide a wide array of weapons that deprive 
franchisees of common law rights. These include waiver of jury trial 
rights, dispute resolution in distant locations, indemnification for 
the franchisor even for its own negligence, one-sided arbitration 
clauses and waiver of required bonds to obtain injunctions. The heavily 
one-sided, take-it or leave-it franchise agreement we see today would 
not be tolerated in any other industry where true competition is a 
reality.
    While prospective franchisees can always decide not to buy 
franchises, many of the provisions our members' find objectionable have 
become ``standard operating procedure.'' It doesn't matter if you're 
looking at franchise A or franchise B--the agreements for both will 
require, for example, that the franchisee waive his/her right to a jury 
trial. In other words, as the 1999 AFA study of the top eight pizza 
franchisors demonstrated, there is no meaningful choice among franchise 
agreements with respect to the legal rights of a franchise. There may 
have been true choice between franchise agreements in the 1960's and 
70's when the promulgation of the FTC's franchise rule was being 
debated, but not today.
    Franchisees joke that they're the only small business people who go 
to sleep one night thinking they're in one kind of business only to 
wake up the next morning in a totally different business. That's 
because franchise contracts can and do change during the term. Most 
franchise agreements provide that the franchisor can change its 
operations manual or other company policies from time-to-time without 
notice to or with the consent of the franchisee. In effect, the 
franchise agreement becomes a moving target for the franchisee because 
the franchisor has the unilateral right to change the terms of the 
deal. This is perhaps the biggest threat to a franchisee's sunken 
investment because the franchisee typically bears the cost of 
implementing whatever change the franchisor decides to make to the 
system.
    Twenty-three years after its promulgation the consumer approach 
taken by the FTC is totally inadequate in protecting the amount of 
money and time invested by franchisees in their businesses. Even when 
franchisees are given the required disclosures the information provided 
is often inadequate, misleading, internally inconsistent, erroneous or 
just missing altogether.
    Mr. Chairman, we believe that franchising has grown from its roots 
as a method of distribution and has evolved into a powerful industry--a 
largely self-regulated, interstate commerce industry. We would like to 
urge Members of this panel to ponder our point-of-view. The 
relationship between franchisor and small business franchisee has 
suffered from benign neglect for too long. Hopefully, this Subcommittee 
will begin a new debate on appropriate guidelines for the future. 
Franchisees have sought more openly disclosed, honest information long 
before the Arthur Anderson accounting revelations. We need to have more 
accountability from the corporations that offer investment 
opportunities and an energized Federal Trade Commission can fulfill its 
consumer protection mandate by insisting upon such from corporate 
franchisors.

    Mr. Stearns. Thank you.
    Ms. Wieczorek. Welcome.

                STATEMENT OF DENNIS E. WIECZOREK

    Mr. Wieczorek. Thank you. Good morning. And thanks for the 
opportunity to appear before you, Mr. Chairman, and the rest of 
the committee. My name is Dennis Wieczorek. I am a partner in 
the Chicago office of the law firm Piper Rudnick. I have been 
practicing franchise law for 25 years. I am appealing today on 
behalf of the International Franchise Association, which is the 
largest association representing the entire franchise 
community, franchisors and franchisees.
    IFA has been and continues to be one of the most vocal 
supporters of the disclosure of a wide range of information to 
prospective franchisees. IFA believes that disclosure is 
critical when an individual is making such an important 
investment decision. If a franchisee and franchisor have a 
mutual understanding of the rights and obligations right at the 
start, there is a much higher likelihood that they will work 
together to make the relationship continue and prosper.
    IFA has been an active participant in formulating the rules 
of franchise offer disclosure. It participated in the creation 
of the Uniform Franchising Offering Circular guideline in the 
1970's, and similarly was involved in the overhaul of those 
UFOC guidelines in 1993.
    A few years thereafter the FTC began the review of its 
franchise rules. IFA has had an extensive role in public 
workshops and hearings and in preparing written comments on the 
rule. While IFA does not agree with all aspects of the rule 
revisions that have proposed by FTC, it is clear to IFA that 
FTC has bent over backwards to the make the rule revision 
process as open and inclusive as possible. We have not yet seen 
the final version of the Franchise Rule, but a few comments are 
appropriate regarding some of the overall trends already 
evident from the FTC's public statements on the rule.
    First, it is important to divorce business opportunities 
from franchises in any new trade regulation rule. The FTC uses 
considerably more resources in enforcement activities against 
business opportunities dollars, and there is no basis for 
tarring franchising with the same brush.
    In addition, the FTC should move toward a single disclosure 
format and take all necessary steps to achieve uniformity in 
the disclosure process.
    While it appears that the FTC is addressing those issues, 
IFA will continue to pursue a number of other changes to 
improve the Franchise Rule. It is essential that the FTC 
recognize the extraordinary costs and burdens that franchisors 
must bear in complying with disclosure rules. The FTC must stop 
short of creating excessive new requirements that add 
unnecessary burdens and unnecessary pages, that erect high 
entry barriers to new entrants into the franchise business, and 
that unduly complicate the disclosures to be read by 
prospective franchisees.
    As you know, the General Accounting Office recently 
completed a study on enforcement of the Franchise Rule. In 
summary, the GAO confirmed that the TFC used most of its 
enforcement resources over the last 7 to 8 years on business 
opportunities, because the overwhelming majority of complaints 
came from buyers of business opportunities, not from buyers of 
franchises.
    The report also states, and I quote, according to FTC 
staff, data the FTC has collected, while limited, suggest that 
franchise relationship problems are isolated occurrences rather 
than prevalent practices.
    The GAO also states in the report that the FTC believes 
that it does not have the statutory authority to intervene in 
private contractual matters, particularly when there is no 
evidence of systemic abuse. IFA believes that this is the right 
approach, and that other methods to resolve relationship 
problems, the National Franchise Mediation Program, IFA's 
ombudsman program, and other internal dispute resolution 
programs, are the appropriate way to deal with those issues. 
That is where nearly all relationship problems should be 
resolved, not in court, and not by a government agency.
    In summary, let us allow FTC the opportunity to do its job. 
It needs more resources. Let us take care of that. IFA may not 
agree with everything that the FTC does, nor with all of the 
changes proposed in the new rule, but IFA endorses the FTC's 
philosophy of franchise regulation. IFA, like the FTC, believes 
strongly in the concept of full and fair disclosure and will 
continue to provide its support for the FTC's efforts to 
improve franchise disclosure.
    Thank you, Mr. Chairman.
    [The prepared statement of Dennis E. Wieczorek follows:]
  Prepared Statement of Dennis Wieczorek, Partner, Piper Rudnick, on 
           Behalf of the International Franchise Association
                              introduction
    Good morning, Mr. Chairman and members of the Subcommittee. My name 
is Dennis Wieczorek and I am here today on behalf of the International 
Franchise Association. I am a partner in the Franchise and Distribution 
Practice group of Piper Rudnick, which has served as General Counsel to 
the International Franchise Association since the association was 
founded in 1960.
    Piper Rudnick is a national law firm with offices throughout the 
U.S. I have practiced as a franchise lawyer for 25 years and have 
worked with clients ranging in size from 1 or 2 unit development stage 
entities to some of the world's largest franchise companies.
The International Franchise Association
    Founded in 1960, the International Franchise Association is the 
oldest, largest and only association that represents the entire 
franchise community, with more than 4,000 individual franchisee 
members, 30,000 franchisee members represented through their franchisee 
associations, 800 franchisor members and 300 franchise supplier 
members. Once a franchisor-only association, the IFA leadership 
recognized a decade ago that to truly serve as the ``voice of 
franchising,'' franchisees should be included as members of the 
association. Since 1993, franchisees have been integrated into all 
aspects of the IFA, including the Executive Committee, Board of 
Directors and committee structure. Currently, a franchisee serves as 
Chairman of the International Franchise Association. Another franchisee 
is Treasurer of the IFA and five other franchisees serve as elected 
members of the IFA Board of Directors.
    The IFA's franchisor members include some of the most recognizable 
names in the U.S. economy, and many of those companies operate 
thousands of franchised units. But the vast majority of IFA's 
membership, more than 70%, operate fewer than 200 franchised units and 
are themselves small businesses. Regulatory compliance burdens for 
those companies can make the difference between success and failure in 
the marketplace, which in turn impacts job creation, economic 
development and entrepreneurial opportunities for franchise investors, 
their families and employees.
    One of IFA's goals in expanding membership to embrace franchisees 
was to ensure that the IFA speaks on behalf of the entire franchise 
community on legislative, regulatory and other public policy 
initiatives that affect franchising. The IFA also actively supports 
vigorous enforcement of, and thorough compliance with, the FTC 
Franchise Rule and state franchise disclosure laws. It is important to 
remember that franchising is a business concept in which franchisors 
and franchisees must work together to ensure the mutual success of the 
enterprise. This requires a careful balancing of both parties' 
interests in order to ensure that the regulatory climate promotes 
continued growth of franchised businesses.
    The IFA's mission is to protect, enhance and promote franchising. 
IFA conducts many programs, seminars and conferences to educate current 
and prospective members of the franchise community, as well as the 
public, about what franchising is and how franchising works. Over the 
years, the IFA has adopted and embraced a number of other initiatives 
to promote healthy and mutually beneficial relationships within the 
franchise community. Primary among these is the IFA's Self-Regulation 
program, which includes the IFA Code of Ethics, the IFA Ombudsman 
program and on-line compliance and education programs for the franchise 
community. The on-line educational programs, Franchise Compliance and 
Franchising Basics, were created to ensure that franchisors fully 
comply with existing federal and state franchise disclosure laws and 
that franchise investors are fully aware of what franchising is and how 
franchising works. All of these programs will help minimize long-term 
disruption to franchise systems and promote expedited resolution of 
business disputes in franchise systems.
    The International Franchise Association has also endorsed, and 
promoted since its inception, the National Franchise Mediation Program 
(``NFMP''), the only program designed specifically for franchising to 
assist franchise systems in mediating resolution to business disputes. 
In addition, a number of franchise systems, working in conjunction with 
the FTC, have created a program known as the National Franchise Council 
(``NFC''). The NFC administers an alternative Rule enforcement program 
to assist the FTC and franchise companies in addressing minor and 
technical violations of the FTC Franchise Rule. These programs, 
developed over a number of years by the IFA and the franchise 
community, demonstrate a commitment to self-regulation and to the 
creation of a business climate in which franchisees and franchisors can 
work together to avoid, identify or resolve potential disputes within 
individual franchise systems.
What is Franchising and What is the Role of Franchising in the Economy?
    Franchising is a strategy for the growth and expansion of a 
business in which the franchisor licenses to the franchisee, for a 
period of time, the trademark, intellectual property, operating and 
business plan and other proprietary information necessary for the 
operation of the business. The franchisor also provides training, 
support and advertising and marketing assistance necessary to promote 
the brand and achieve continued brand recognition and market 
penetration. In return for the right to operate this carefully tested 
and proven system, the franchisee makes regular royalty payments to the 
franchisor, usually on a monthly schedule and calculated using the 
gross monthly revenue of the franchised unit as a basis.
    Franchise relationships are unique business arrangements based upon 
a contract between the franchisee and the franchisor in which the 
obligations, rights and remedies of the parties are spelled out in 
great detail. Federal and state disclosure laws, such as the FTC 
Franchise Rule, identify specific criteria that distinguish a franchise 
from other forms of distribution relationships. These criteria include 
a registered trademark; the on-going payment of royalties or other 
fees; and a continuing and significant involvement of the franchisor in 
the operation of the franchised business.
    Franchising is not an industry, instead it is a strategy for 
business growth and expansion that has been successfully employed by 
more than 75 different industries, ranging from hotels to printing to 
real estate to restaurants and scores of others. The services and 
products offered by these businesses to their customers vary widely, as 
do the manner in which companies in these industries operate their 
businesses.
    Today, franchising accounts for approximately $1 trillion in sales, 
or nearly 50% of all retail sales in the U.S. According to the Profiles 
in Franchising study conducted by the IFA Educational Foundation, there 
are 320,000 franchised units in the U.S. which employ 8 million people. 
Franchising is an incredibly successful method of expanding a brand 
that has created hundreds of thousands of entrepreneurial 
opportunities, giving franchisees the opportunity to be in business for 
themselves but not by themselves. In the process, franchising has 
created literally millions of jobs and become an engine of small 
business growth and development in our economy, and today is 
responsible for sharing America's free enterprise values with more than 
100 other nations.
The Benefits of Presale Disclosure
    The International Franchise Association appreciates the opportunity 
to participate in today's discussion of the FTC Franchise Rule and the 
effectiveness of the Rule in promoting a healthy and balanced 
regulatory climate for the franchise community and American consumers. 
The IFA has worked with the FTC since the early 1970's to help craft a 
federal disclosure rule that will provide prospective franchise 
investors with the information necessary to make an informed business 
decision about a franchise investment, while simultaneously maintaining 
a reasonable compliance burden for franchise systems.
    The IFA has always vigorously supported the enforcement of 
disclosure laws because prospective small business franchisees, 
franchising and its customers are best served when those investing in a 
franchise have all relevant information about the franchise prior to 
making the franchise investment. In particular, the International 
Franchise Association has been actively involved in working with the 
FTC since 1995 on the FTC's proposed revisions to the Rule, and has 
appeared at numerous public workshops to discuss those revisions and 
submitted a number of written comments (attached to my remarks) 
expressing the International Franchise Association's perspective on the 
proposed revisions to the Rule.
    The International Franchise Association is firmly committed to the 
disclosure process because we believe it is critically important for 
franchise investors to have realistic expectations about how franchised 
businesses operate, and about the interdependent relationship between 
franchisors and franchisees. Investing in a franchised business is not 
a guarantee of success. Franchised businesses, like any other free 
market enterprises, require commitment, hard work and dedication (among 
other things) in order to be successful.
    One of the IFA's primary functions is to serve as a resource for 
the public and potential investors to educate them about what 
franchising is, and how franchising works. Franchising is not for 
everyone. Franchised businesses are based on the standard and uniform 
appearance, operation and delivery of products and services to 
customers. This requires franchisees to adhere to, and comply with, 
minimum quality standards established by the franchisor for the 
operation of the business. The requirement to adhere to operating 
standards may be something that is not universally appealing to all 
independently-minded entrepreneurs.
    The beauty of the franchise disclosure process is that while there 
are literally hundreds of franchised businesses from which an 
entrepreneur can choose, the disclosure process provides the future 
small business franchisee with the framework within which to conduct a 
thorough and comprehensive evaluation of those investments. As a result 
of this evaluation, the franchise investor can make a decision about 
which, if any, is the right investment. That is one of the reasons that 
the IFA promotes and distributes the FTC's Consumer Guide to Buying a 
Franchise. For years, the FTC Guide has been republished in IFA's 
Franchise Opportunities Guide, posted on our website and disseminated 
to thousands of news media outlets to increase public awareness. The 
FTC Guide provides franchise investors with guidance about what 
information is important in evaluating a franchise and how to obtain 
and evaluate this information. The Guide also recommends that franchise 
investors retain professional services of legal and financial experts 
to assist in a thorough evaluation of all presale information obtained 
as part of the disclosure process.
    This evaluation also requires a considerable amount of self-
evaluation and introspective thinking about the business or industry in 
which a franchise investor wants to be involved. If the prospective 
investor determines that none of those investments are attractive, the 
future entrepreneur is free to establish his or her own independent 
business. The disclosure process provides the information necessary to 
reach a fundamental decision about whether to make the investment, and 
to compare between and among franchise systems in order to find the 
franchised business that matches an individual's interests, skills and 
needs.
The FTC Disclosure Rule and Proposed Revisions
    As noted earlier, the International Franchise Association's 
longstanding support for the disclosure process is rooted in our belief 
that disclosure regulations strike the appropriate balance between the 
investor's need for information and the legitimate concerns of 
franchise systems about overregulation in the marketplace. The IFA 
commends the FTC staff for the manner in which they have conducted the 
process leading to the review of the franchise rule. We have actively 
participated in this process, beginning in early 1995 with the informal 
request for comment, the first public workshop in September 1995, the 
subsequent workshop in March, 1996, the Advanced Notice of Proposed 
Rulemaking in early 1997, the subsequent regional workshops held around 
the country in 1997 and the Notice of Proposed Rulemaking in 1999. We 
believe that the inclusive and thorough approach adopted by the FTC in 
this rulemaking effort resulted in a process that provided ample 
opportunity for all interested parties to participate, and has produced 
a record that clearly identifies the areas addressed by the Rule that 
are most in need of revision.
GAO Audit
    The IFA also participated in numerous discussions with the General 
Accounting Office (``GAO'') during the 2000-2001 audit conducted by the 
GAO on the Enforcement of the FTC Franchise Rule. We believe that the 
results of the GAO audit affirm our long-held beliefs that: (1) the 
vast majority of complaints alleging violations of the franchise rule 
(more than 92% according to the GAO) involve business opportunities, 
not franchises; (2) the FTC effectively enforces the Rule; and (3) 
there is no empirical data to support the notion that there are 
pervasive problems in franchise relationships.
    According to the July 31, 2001 GAO Report on Franchise Rule 
Enforcement:

 From January 1993 to June 1999, a seven year period, the FTC 
        received 3,680 business opportunity and franchise complaints, 
        with 92% involving business opportunities and 8% involving 
        franchises. (GAO-01-776, pages 3,10)
 During the same period, and after analyzing complaints, the 
        FTC launched 332 investigations. 162 cases went to court for 
        violations of the Franchise Rule and/or section 5 of the FTC 
        Act (which declares unlawful unfair or deceptive acts or 
        practices in or affecting commerce.) (GAO-01-776, pages 13,16)
 Of the 162 cases, 88% or 142 involved business opportunities, 
        only 12% or 20 involved franchises. In each of the 162 cases 
        brought to court, the FTC obtained some form of relief, 
        including injunctions, civil penalties or monetary redress for 
        investors. (GAO-01-776, pages 3,10)
 Since the Franchise Rule review process began in 1995, the FTC 
        has received comments or statements for the record from a total 
        of 96 individual franchisees or trademark-specific franchisee 
        associations. FTC staff noted that nearly half of the comments 
        submitted were identical form letters that discussed their 
        general support for broader franchise relationship controls but 
        shed little, if any light, on their specific experiences. FTC 
        staff also reported more than half of the comments raised 
        issues involving only three franchisors. The FTC said there was 
        little consistency among the remaining individual comments, 
        which covered a wide range of issues. (GAO-01-776, page 22)
 FTC staff stated that the isolated instances of franchise 
        relationship problems do not justify FTC conducting a more 
        widespread investigation of relationship issues or developing a 
        new rule that addresses the terms and conditions of franchise 
        contracts. (GAO-01-776, page 23)
 According to FTC staff, data the FTC has collected, while 
        limited, suggest that franchise relationship problems are 
        isolated occurrences rather than prevalent practices.'' (GAO-
        01-776, page 4)
IFA Comments on Proposed Revisions to Franchise Rule
    The attached written comments submitted by the International 
Franchise Association to the FTC as part of the rulemaking process 
spell out in great detail the specific areas in which we believe the 
Rule should be revised. I will not repeat in detail each and every one 
of those comments in these remarks. However, I would like to highlight 
several issues of great interest to the International Franchise 
Association and its members which we believe are among the most 
important aspects of the proposed revisions to the Rule.
The FTC and UFOC
    The FTC disclosure format coexists with a franchise disclosure 
format developed by a number of states called the Uniform Franchise 
Offering Circular (``UFOC''). The UFOC disclosure format and the FTC 
format are similar, but not identical, and the UFOC disclosure format 
is required in nearly all of the states that have enacted their own 
franchise disclosure laws. The FTC disclosure format is not accepted in 
those states.
    Both the FTC and UFOC disclosure formats require, among other 
things, the disclosure of such items as the business experience of the 
franchisor; its litigation and bankruptcy history; franchise fees, 
royalties and other payments required under the franchise agreement; 
requirements for purchase of inventory, equipment or supplies; 
territorial restrictions; transfer or termination of the franchise; and 
financial statements; and contact information for current and former 
franchisees of the system. However, there are differences between the 
format and detail required under the FTC and UFOC documents, which can 
generally be described as deficiencies in the FTC format.
Adoption of UFOC Format for Disclosure
    One of the proposed changes to the FTC Rule is to adopt the UFOC 
format for disclosure, which would enhance uniformity of the disclosure 
document that franchise investors receive and would simultaneously 
streamline and simplify the disclosure process for franchisors. And 
because state regulators updated their disclosure format several years 
ago, by adopting the UFOC format the FTC will not only harmonize its 
rule with the state format, but will also significantly modernize its 
rule. The IFA strongly supports this proposed change to the FTC Rule.
Separate Rule for Franchises and Business Opportunities
    The IFA also supports the recommendation that business opportunity 
ventures be removed from coverage of the Franchise Rule. We believe 
that the structure, operations and experiences of business format 
franchises--IFA's members--are sufficiently different from business 
opportunities to warrant creation of a separate rule for each. We 
applaud the recommendation that the Rule distinguish between business 
format franchises and business opportunities.
Electronic Disclosure
    We also strongly support a revision to the Rule to permit 
electronic disclosure. The FTC staff clearly recognizes the benefits 
recent technological advances offer in providing a mechanism for swift, 
cost-effective disclosure. We do have some concern that continuing to 
require a franchisor to furnish hard copies of select portions of the 
disclosure document undermines the effectiveness of this provision. 
However, we believe that if the FTC adopts a mechanism that will permit 
minor revisions to this requirement as electronic filing becomes more 
prevalent, the Rule may preserve the beneficial effects of electronic 
disclosure for both franchisees and franchisors.
Application of Rule to Exclusively Domestic Franchise Sales
    The IFA also supports the FTC recommendation that the rule be 
clarified to reflect its application to exclusively domestic--as 
opposed to international--franchise sales. We agree that there is no 
benefit to prospective foreign investors from attempting to apply the 
Rule extraterritorially, and we believe that in fact such attempts may 
result in confusion about or conflict with regulatory and statutory 
obligations in foreign jurisdictions.
Earnings Claims
    Finally, the IFA strongly supports the FTC's recommendation that 
the Rule not contain a mandatory earnings disclosure. The IFA believes 
that a mandatory, one-size fits-all approach to financial performance 
information is impractical and could actually impair the advance of 
free enterprise franchising, as it fails to take into consideration the 
many variations that exist among the scores of industries and thousands 
of companies that employ franchising as a method of expanding their 
businesses.
    The IFA agrees with the FTC that such information is currently 
available, either directly from franchise companies that make earnings 
disclosures or through direct communication with current and former 
franchisees. IFA believes that the competitive force of the marketplace 
should drive the decision-making process regarding whether or not 
individual franchise systems make earnings disclosures. We are very 
encouraged that the FTC has adopted a similar philosophy in its 
decision not to mandate uniform disclosure of earnings information.
Conclusion
    Let me conclude by thanking you, Mr. Chairman and the members of 
the subcommittee for giving the International Franchise Association the 
opportunity to appear here today to discuss these important issues. The 
IFA strongly believes that the FTC disclosure rule has had a positive 
impact on the evolution of franchising, and that the Rule has helped 
create a climate in which thousands of businesses and tens of thousands 
of entrepreneurs have had an opportunity to achieve the American dream 
of being in business ``for themselves, but not by themselves.''
    The IFA believes that the proposed revisions to the FTC Franchise 
Rule will be beneficial in modernizing the Rule, and ensuring that 
prospective franchise investors have ready access to meaningful and 
reliable information about franchise investments. Armed with this 
information, entrepreneurs can conduct due diligence in researching 
these franchise investments, make informed decisions about their 
investments and enter the small business franchise community with 
realistic expectations about what franchising is and how franchising 
works.
    As ``The Voice of Franchising'' for more than 40 years, the IFA 
will continue to work with the FTC to complete revisions to and 
implementation of the revised Franchise Rule.
    Thank you again for inviting me to appear here today. Good morning.

    Mr. Stearns. I thank you.
    And Mr. Rizer. Welcome.

                    STATEMENT OF JERRY RIZER

    Mr. Rizer. Thank you. My name is Jerry Rizer. My home is in 
Elizabethtown, Kentucky. I own and operate three Dairy Queen 
stores. I have been a Dairy Queen franchisee operator for 20 
years. I am also the president of the Dairy Queen Operators 
Association, and the Dairy Queen Operators Cooperative, which 
represent over 1,400 DQ franchisees and 3,900 DQ franchisees 
respectively.
    The Dairy Queen system in the United States employs 
approximately 160,000 people including many teens holding their 
first jobs. In the aggregate we purchase as much as $400 
million annually in equipment and supplies.
    The FTC rule and its enforcement of the rule has been 
woefully deficit in three major ways. No. 1, the rule affords 
us no protection against the most dangerous threats to our 
existence: abuse of competition by our franchisor in our supply 
chains, and encroachment on our developed stores by new stores 
franchised by our own franchisor.
    No. 2, astonishingly the rule allows big franchisors like 
IDQ to sell franchises without disclosing track records of 
financial performance of existing franchised stores, and 
without disclosing the financial impact on new or existing 
franchisees of IDQ's manipulation of supply chains or 
encroaching new store development.
    No. 3, Federal law does not allow franchisees who are 
injured by franchisors' blatant violation of the rule through 
deceptive misdisclosure, or omission of material information, 
or even outright fraud to bring a legal action to recover their 
losses cause by the violation.
    Mr. Chairman, we know that you are aware of the findings of 
the GAO audit last year of the FTC's enforcement of franchising 
rule, that the vast majority of franchise complaints of the FTC 
involve postsale relationship problems, like those described 
above, that the FTC doesn't even investigate the vast majority 
of even the legitimate franchise complaints it receives, and 
that in the last 5 years the FTC has brought only legal 
enforcement action against a franchisor during a period when 
literally thousands of private lawsuits have been filed under 
State franchise laws where those exist.
    It is absolutely incomprehensible to our association that 
franchisors can violate the FTC rule with apparent impunity 
because the FTC lacks the resources or the will to enforce its 
own rules, and Federal law does not provide private parties the 
right to sue for harm caused by violations of the rule. The 
rule is a paper tiger.
    Mr. Chairman, it would be a simple matter indeed for 
Congress to redress this travesty with legislation as simple as 
amending the Federal Trade Commission Act or the Clayton Act to 
add this: Section blank. A person who is injured by a violation 
of the trade regulation rule on franchising, CFR Part 436, as 
it now exists or as it may subsequently be amended or 
recodified may bring an action against the person who committed 
the violation in a State or Federal court of appropriate 
jurisdiction for damages, rescission, cancellation, or such 
other relief as the court deems appropriate, and is entitled 
also to recover the person's costs and attorney fees to obtain 
relief.
    If, as the franchisors and their trade association assert, 
all is well in franchising, and presale disclosure cures 
whatever problems exist, the private right of action will not 
produce any measurable burden on the court system or the 
franchisors. Courts have ample power already to sanction 
frivolous or unfounded complaints, so that is not an issue. But 
where real harm has been caused, it will for the first time 
afford at least the opportunity for justice to be done.
    Thank you for consideration of these views.
    [The prepared statement of Jerry Rizer follows:]
  Prepared Statement of Jerry Rizer, President, Dairy Queen Operators 
                           Association, Inc.
    The Dairy Queen Operators Association (``DQOA'') and the Dairy 
Queen Operators Cooperative (``DQOC'') presents these views to the 
Committee for its oversight of the United States Federal Trade 
Commission's enforcement of its Trade Regulation Rule on Franchising 
(16 C.F.R. Part 436) (the Rule).
    DQOA/DQOC is an independent trade association and cooperative 
representing the interest of more than 3.900 Dairy Queen stores in the 
U.S. owned by American entrepreneurs. The typical Dairy Queen owner 
owns just one or two store(s), and for most, this investment represents 
substantially all of the owner's (and his family's) net worth. Dairy 
Queen franchisees are owner-operators--they get their hands dirty 
working these stores themselves.
    Dairy Queen franchisees in the U.S. employ approximately 160,000 
people, including many teens holding their first jobs, learning the 
virtues of hard work, punctuality, and serving customers. In the 
aggregate, we purchase as much as $400 million annually in equipment 
and supplies. A new Dairy Queen store can cost as much as a million 
dollars to build.
    The business is highly risky. Under the best circumstances, the 
pre-tax operating margin on a. Dairy Queen/Brazier store, before 
allocating profit to the owner, is just 10%, leaving very little to 
compensate the owner for his or her hard work and investment. We pay a 
``tax'' to our franchisor of 4% of our top line sales, and a mandatory 
``tax'' to a national marketing fund 100% controlled by our franchisor 
of as much as 6%. We therefore have only 90% of our sales to cover our 
payrolls, our vendors' bills, our bank loans, and our real taxes, and 
that all comes after our franchisor, who always gets ``first dollar.'' 
With what amounts to a razor-thin margin, our franchisees struggle, to 
earn a minimal return on investment and a living income with the last 
dollars left after everyone else is paid.
    We have had severe challenges running our businesses and making our 
payrolls, and some of the worst of these come from our own franchisor, 
International Dairy Queen, Inc, (``IDQ''), which is owned by multi-
billionaire Warren Buffett's company, Berkshire-Hathaway.
    The FTC's Rule and its enforcement of the Rule has been woefully 
deficient in three major areas:

1. The Rule affords us no protection against the most dangerous threats 
        to our existence abuse of competition by our own franchisor in 
        our supply chains, and encroachment on our developed stores by 
        new stores franchised by our franchisor.
2. Astonishingly, the Rule allows big franchisors like IDQ to sell 
        franchises without disclosing the track record of financial 
        performance of existing franchised stores, without disclosing 
        the financial impact on new of existing franchisees of IDQ's 
        manipulation of supply chains or encroaching new store 
        development.
3. Federal law does not allow franchisees who are injured by a 
        franchisor's blatant violation of the Rule--through deceptive 
        misdisclosure, or omission of material information, or even 
        outright Fraud--to bring a legal action to recover their losses 
        caused by the violation.
                             rule omissions
    Sourcing. The Rule mandates selected disclosures prior to the sale: 
of a franchise. But, it does not even address the many pernicious 
practices of many large franchisors such as IDQ which cause widespread 
and significant harm to franchisees.
    IDQ was not content to receive just its 4% off-the-top royalty and 
5 to 6% marketing fee (part of which covers IDQ's corporate costs 
relating to advertising and marketing). IDQ also took enormous fees, 
which many of our members regard as naked kickbacks, from suppliers 
based on franchisees' purchasing volume. IDQ also took huge markups on 
goods it resold to franchisees. And to protect this huge income stream, 
IDQ abused its market power over the Dairy Queen system to try to keep 
franchisees--through their independent purchasing cooperative--from 
using independent competitive sources for equipment and supplies. IDQ's 
abuses of sourcing cost our system tens of minions of dollars of 
unnecessary and avoidable costs every year. The Rule doesn't even 
address these abusive and anticompetitive practices.
    In 1994 we were forced to sue IDQ to stop the practices. Because of 
the deficiencies in federal law, it was an uphill fight. In 2000, we 
finally settled the case, but IDQ has still not cooperated with its own 
franchisees. preferring to try to hold onto its huge sourcing revenues. 
It took us six years of hard-fought litigation to reach a compromise 
settlement because the FTC Rule does not prohibit franchisors from 
abusing their authority over sourcing, to allow the free interplay of 
normal competitive forces in the marketplace to work for franchisees. 
And federal courts have declined to apply normal principles of 
antitrust law to franchise systems, allowing franchisors to monopolize 
and abuse supply chains in their systems to the detriment of 
franchisees who are locked in by the iron chains of grotesque franchise 
contracts drafted by huge: franchisor law firms without the chance for 
franchisees to negotiate or influence the terms of those contracts.
    Encroachment. Those same one-sided. oppressive contracts allow. and 
the FTC Rule does not even address, big frannchisors like IDQ to 
compete against their own franchisees by encroaching on established 
franchisees with new stores. The franchisor profits, the franchisees 
lose, and the Rule ignores the whole problem.
    Here is an example to illustrate our plight. Suppose a town has an 
established Dairy Queen (or any other franchised small business). 
Suppose the existing store has annual gross sales of $700,000. IDQ gets 
the first 4% of that, or $28,000. Suppose IDQ franchises a second store 
in that same market, with the result that their combined sales are $1.1 
million. IDQ's take goes up to $44,000, but each store only takes in 
(on average) $550,000. The existing franchisee's sales have dropped by 
$150,000, which is probably more than that owner was making before the 
encroachment occurred. In other words, Warren Buffett's franchisor's 
income went up by more than half, but the franchisee lost his entire 
profit, or a very large part of it.
    The FTC Rule allows this to occur. The FTC Rule doesn't even 
require disclosure of this impact much less prohibit this kind or 
plainly unfair trade practice. And this happens every day throughout 
this country.
    I would venture to guess that no franchisee anywhere bought his or 
her franchise expecting his own franchisor to become his biggest 
competitive nightmare. Yet federal law allows this to happen.
    Financial Disclosure. I was shocked when I first learned that the 
FTC Rule allows franchisors to sell franchises without telling their 
prospective buyers how existing units are doing financially, or what 
the buyer might expect to do with his franchise. What could be more 
basic or more important to a buyer than financial performance data? Our 
franchisor already has the data, and I'm sure most others do, too. But 
they are allowed conceal that vital information because the Rule makes 
that disclosure optional.
    What if the franchisor knows that a large portion of its 
franchisees are struggling financially? Why in the world should the FTC 
allow the franchisor to hide that from a prospective new franchise?
    The same is true of disclose of the financial impact of franchisor 
interference with free competition in sourcing, or of franichsor 
encroachment. Why shouldn't the FTC require a large franchisor like IDQ 
or McDonald's or Holiday Inn to have to disclose such simple data as:
        ``Our involvement in the supply chain in this system adds about 
        x% to your costs of doing business,'' or
        ``If we use our right to encroach on your franchise, it may 
        take away as much as 50 to 100% or more of your operating 
        profit.''?
                            private remedies
    Mr. Chairman, we know that you arc well aware of the findings of 
the GAO audit last year of the FTC's enforcement of the Franchising 
Rule that the vast majority of franchise complaints to the FTC involve 
post-sale relationship problems like those described above, that the 
FTC doesn't even investigate the vast majority of even the legitimate 
franchise complaints it receives, and that in the last five years the 
FTC has brought only one legal enforcement action against a franchisor 
(during a period when literally thousands of private lawsuits have been 
filed under state franchise laws where those exist).
    It is absolutely incomprehensible to our association that 
franchisors can violate the FTC Rule with apparent impunity, because 
the FTC lacks the resources or the win to enforce its own Rule AND 
federal law does not provide private parties the right to sue for harm 
caused by violation of the Rule. The Rule is a paper tiger.
    Mr. Chairman, it would be a simple matter indeed for Congress to 
redress this travesty with legislation as simple as amending the 
Federal Trade Commission Act, or the Clayton Act, to add this:
        Section. ---- A person who is injured by a violation of the 
        Trade Regulation Rule on Franchising, C.F.R. Part 436, as it 
        now exists or as it may subsequently be amended or recodified, 
        may bring an action against the persons who committed the 
        violation in a State or federal court of appropriate 
        jurisdiction for damages, rescission, cancellation or such 
        other relief as the court deems appropriate, and is entitled 
        also to recover the person's costs and attorneys fees to obtain 
        relief.
    If as the franchisors and their trade association assert all is 
well in franchising and presale disclosures cure whatever problems 
exist, this private right of action will not produce any measurable 
burden on the court system or the franchisors. Courts have ample power 
already to sanction frivolous or unfounded complaints, so that it is 
not an issue. But, where real harm has been caused, it will--for the 
first time--afford at least the opportunity for justice to be done.
    Thank you for your consideration of these views.

    Mr. Stearns. Thank you.
    Let me just say, Mr. Rizer, if we allowed a franchisee to 
sue in his State, then you would have 50 States in which you 
would have suits, and in all deference to the company, you 
know, you can have a lot of nuisance suits. It can drive a 
company out of business. So the idea of allowing private right 
of action in each State--now, Mr. Rush and I might not agree on 
this, but I have some concern of allowing a franchisee to sue 
in separate States.
    I notice here in Pizza Hut, they say if you are going to 
sue, it will have to be in Kentucky. I think it says--anyway, 
they specify where you have got to sue. You can see that 
perspective, can't you, that it would just be very difficult 
for a company to sustain litigation from 50 States, going into 
50 different courts? That is just a comment.
    I think what you suggested and what others have suggested, 
including mandatory earnings disclosure in its revised 
Franchise Rule, I think is good. Can I just ask down the panel, 
do you think the idea that the FTC should--although right now I 
understand they are not including mandatory earnings disclosure 
in its revised Franchise Rule, do you think that they should?
    Mr. Cantone. Speaking for NASA, NASA has been on record for 
years as supporting in concept mandatory earnings disclosure, 
and, in fact, NASA had worked for the last several years to try 
to propose mandatory earnings claims at the State level. But 
for practical reasons, and one of the main reasons is because 
the Federal Trade Commission has signaled it is not going to 
mandate earnings claims, it kind of made us stop on that 
process for the time being because of issues of uniformity.
    So we think if there is mandatory earnings disclosures 
which support in theory, it is best to be adopted on a uniform 
national basis because of issues of uniformity so that 
everybody has the same rules and not just rules in certain 
States.
    Mr. Stearns. My question, though, then the parent company 
has to come up with historical data. That might be for a good 
operator. But you have a weak operator, and the person who gets 
it will say, I didn't get those figures. That is because you 
didn't do what the company told you to do. That historical 
information has some problems with it, depending on the 
operator, whether he does what the franchisor tells him what to 
do, and whether he has good business sense, whether he is 
putting capital in the property. If he just drains the property 
dry, and you show up and there is no flowers, there is 
dirtiness in the restaurant or motel room, it doesn't matter 
what the historical data shows. You cannot sue based upon your 
lack of performance. So those are one of the problems.
    Go ahead.
    Mr. Wharton. I addressed it a little bit in my remarks, Mr. 
Chairman, but basically I think that there is a practical 
problem in trying to get--because it is so diverse. Franchising 
is not----
    Mr. Stearns. So you don't think that you could come up with 
a standardized historical information that would be applicable 
which the franchisee could take to the bank?
    Mr. Wharton. I think it would be very difficult, and I 
think that the alternate is to get it from--what we suggest 
when someone is coming in is talk to as many of those existing 
owners. They are all listed in our UFOC. Talk to them.
    Mr. Stearns. Make them do the due diligence before they 
buy.
    Mr. Wharton. Exactly. Find people that are not doing well. 
Make sure you find someone that is not doing well. Understand 
why.
    Mr. Stearns. I have a friend who opened up a Burger King, 
and he did it in university town, and he did real well until 
the university had a Burger King within the student union. It 
took all of his business, so he is thinking about suing. You 
know, you could have given him historical data. It wouldn't 
have been meaningful for his site. It might have showed that 
you are going to make a million dollars in gross a year, but if 
someone opens up and the student union has it right there, then 
no one is going to go off campus to get it. So, you know, go 
ahead.
    Ms. Kezios. Not having historical financial performance 
information when you buy any business is not done in any other 
commercial activity except franchising. Why should franchisees 
have to buy a business and guess perhaps at what franchisees 
have done in the past? I used to be a franchise broker 20 years 
ago. The joke was, as we were selling franchises, if the 
franchisors had to report historical financial performance 
data, half of the franchisors wouldn't be franchising today 
because people can't make any money.
    Now, I have got a document here from Growbiz International, 
their uniform franchise offering circular. They are providing 
an Item 19. So for some reason they found it easy. They have 
got the data. Franchisors get this data, Mr. Chairman. Some 
days at the end of the day they know exactly what the 
franchisees have done. This is like buying a car without an 
engine. It doesn't make any sense not to have historical 
financial performance data.
    Mr. Stearns. Okay.
    Mr. Wieczorek. This is a remedy. This is a remedy in search 
of a problem. If franchisees are interested in a business, they 
should talk to every conceivable person that is listed in the 
document. If someone is a prospective Dairy Queen operator, 
they can call up Mr. Rizer and say, how are your stores doing? 
That is what they should do. That is incumbent on them to do 
it. Information is available now.
    Mr. Stearns. It is like when a person goes in to buy a 
business, you know, you have to do the due diligence to find 
out--if the owner says, we are grossing XYZ, you better look at 
the sales tax to be sure that is true. You probably should sit 
there and look at the business, to see what goes in, because 
lots of times, unless you do your due diligence, those 
historical figures don't mean much.
    Mr. Rizer.
    Mr. Rizer. There is an inaccuracy here in what people are 
saying. The document that you are showing up here doesn't list 
a list or is not required to list a list of current and former 
franchisees, or at least it is not being complied with at the 
present time. So as the fellow next to me is suggesting they 
call me, they would only call me if my name and number was 
listed. The uniform offering agreements that I have received 
list only those locations in the State that I reside.
    Mr. Stearns. But Pizza Hut, it looks like it has all of the 
open franchise stores. I mean, there is just gobs of names here 
that I could call.
    Mr. Rizer. I received the document. I received one a few 
weeks ago. It only had Kentucky in it. That is all I have ever 
been told was required.
    Mr. Wieczorek. Most franchisors will list all of their 
franchisees, but the guidelines do permit you to list at least 
100 in the State that you are in or States contiguous to you. 
So every UFOC will have at least 100 franchisees listed in it, 
but they must include all former franchisees who left the 
system in the last year. So there is another group that they 
can talk to also.
    Mr. Stearns. My time has expired.
    Mr. Rush.
    Mr. Rush. Mr. Wharton, you testified against requiring 
earnings disclosures because each business is different. 
However, the SEC, the Securities and Exchange Commission, has 
been successfully requiring uniform earnings disclosures of 
publicly traded companies for decades. Now, how is this any 
different? And I would like for all of the panelists to take a 
stab at this. Be brief if you can.
    Mr. Wharton. Basically, Congressman, I think that one of 
the issues is that the information that is gathered in the 
franchise context has to come from the owner themselves or the 
franchisee that is out there in the market, and they may or may 
not provide accurate information for various reasons. With the 
SEC rules, you are reporting on information that your company 
has control over.
    Ms. Kezios. Well, the argument that you have no control 
over what the franchisee reports is moving the question. I 
mean, the franchisee is reporting the information. That is what 
you put in the document. I mean, that is avoiding the question 
totally.
    Mr. ZWieczorek. Congressman, the only information that a 
franchisor usually gets is sales information. It does not get 
on a consistent, reliable basis cost and expense data from 
franchisees, so that, in effect, what a lot of people are 
saying is that you should give earnings. It is almost 
impossible to give earnings because you can't get that data 
from franchisees, you can only get top line sales data.
    Ms. Kezios. In certain franchise chains, they do have all 
of that information. They know exactly. They prepare the 
financial statements for the franchisees. So it is not standard 
what Mr. Wieczorek is just mentioning.
    Mr. Rizer. I have got three letters at home from 
International Dairy Queen's attorney requesting that I provide 
a P&L listing the sales, the cost of goods, the expenses in 
each and every category. This comes once a year to me, and I 
provide that information.
    Mr. Rush. Mr. Cantone.
    Mr. Cantone. Most franchisors don't provide any 
information, including gross sales information. The numbers 
that we are saying are approximately 80 percent of franchisors 
provide absolutely no earnings information at all, and I think 
that is something that a prospective franchisee should take a 
look at as to what is the answer to that question: Why are you 
not giving this information? And I think it can be very 
telling. It is very difficult for franchisors, however, to put 
together really meaningful earnings information. It is a very 
complex area, but I do think it is something that franchisors 
should really strive to do, and they haven't done it 
voluntarily, so I think the time certainly is right for 
somebody to take a hard look at whether or not they should be 
forced to do it.
    Ms. Kezios. In the 1960's when the rule was promulgated, 
the reason that this disclosure is a voluntarily disclosure is 
because there were folks in those days selling franchises 
saying, give me $10,000; you will make $1 million next year. 
That is why that was put--this is 23 years later. That doesn't 
happen anymore. Those guys don't sell franchises like that. 
They know how to sell them without making that kind of a 
blatant earnings disclosure.
    What is worse is we know that the information is being 
given out there, perhaps not in that blatant a manner, but it 
is being given out there, and we need the information in a 
document. We need it reliable, and we need it accurate.
    Mr. Rush. Ms. Kezios, the FTC states, based on the data 
they have, that franchise relationship problems are isolated 
occurrences. Why aren't there more franchise complaints against 
those kinds of postsale franchise relationship problems to the 
FTC?
    Ms. Kezios. The 1993 GAO audit of the FTC was like putting 
a neon sign on the door of the Commission saying, don't bother, 
franchisees, because the 1993 audit pointed out that the FTC 
acted on less than 6 percent of all franchise complaints 
brought to it. So franchisees are, why do we even bother? 
Susan, why are you telling us to complain with the FTC for? 
Which we have continued to do, which is why we surmise there 
has been an increase in the complaints.
    Now, the FTC data doesn't reveal the full extent and nature 
of franchise relationship problems. They don't have enough data 
to begin with. So for them to make that conclusion is erroneous 
to begin with. They don't have enough data on the franchise 
relationship problems.
    I would say that over 90 percent of the complaints that 
come to me have to do with postsale or a combination of pre- 
and postsale. What bigger number do you need to show that a 
preponderance of the complaints have to do with postsale?
    Mr. Rush. Mr. Wieczorek, what types of litigation, if any, 
do franchises have to list in their disclosure documents?
    Mr. Wieczorek. Right now a franchisor is required to list 
all claims made against them by franchisees and also any 
counterclaims that may be made by a franchisee if a franchisor 
sued the franchisee. There is a requirement that it be 
material. If someone sues you for 10 cents, you don't have to 
put that in, but any material litigation does have to be 
disclosed. And that goes for current actions, plus you must 
report all litigation that has been resolved unfavorably 
against the franchisor for the last 10 years.
    Mr. Rush. Mr. Chairman, I got one additional question. Let 
me just ask this question.
    As I traveled through America, you know, a lot of times by 
car, and I go to different communities, I am always astonished 
by in the--in some communities there is a lot of franchise 
options for consumers, a lot of different stores. But when I 
return home to central city America, to my own Chicago, then I 
can count maybe on one hand the number of franchises that is 
really being in business in communities like mine.
    I wonder if someone can give me some idea about what is the 
difference there? I know that there are--all of the expert 
testimony and all of the research says that in central city, 
low-income areas, sales are explosive in terms of consumer 
sales. Every time there is a Kentucky Fried Chicken franchise 
opened up, or Burger King franchise opened up something, they 
always break records. I remember when McDonald's first came to 
the west side, on the west side of Chicago, on Madison, broke 
all kinds of records for the first few months of operation.
    But it seems as though there is a barrier, some kind of 
wall. We can't get more franchised business located in central 
city communities. Can anybody take a stab at that, or is that 
something that you have looked at or thought about? If not, I 
would like to invite you to tour some of those communities and 
see the differences, because, I mean, it makes excellent 
business sense. And I am not sure if there is just not--you 
don't see the opportunities. Sometimes we can only see the 
opportunities in our background because that is where we focus 
at, but I am telling you there is a real serious issue in terms 
of diversity in terms of franchise opportunities, certainly in 
my community.
    Mr. Wieczorek. One of the main issues is capital, and these 
days with the banking and financial industry the way it is, it 
is difficult to find capital for anybody to expand. But 
franchisors in a number of concepts, particularly in the food 
business, are trying to open more doors to minorities and women 
and others to open franchises, but a lot of it is a lack of 
capital in trying to find financial resources to get those 
businesses open.
    So I think that there are efforts to do that, but it is 
difficult in these economic times.
    Mr. Rush. I want to work with you on that, because I don't 
think that is really the case. I really don't think--I mean, I 
think it is a question of having a determined approach to it.
    Thank you, Mr. Chairman.
    Mr. Stearns. Thank you.
    Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. And I will wax 
philosophically for a few minutes before I ask a question or 
two.
    First of all, we appreciate the jobs and economic 
development, growth of both the franchisors and the 
franchisees. This is a debate of being torn between two lovers 
and trying to pick out--trying to slice the baby and figure out 
what we need to do. A lot of our experience up here is--mine 
would be based upon a Flintstones episode where Barney and Fred 
wanted to buy a--I think it was a tyrannosaurus rib shack. And 
so the local used car dealer next to them put a whole bunch of 
cars around the little restaurant, and they bought it, 
obviously. They weren't well informed. And they couldn't turn a 
profit. And I actually remember the jingle from the waitresses 
who were trying to sing the song as they were trying to get 
people to work there.
    So what you would like the--you really need to get together 
and solve this problem before you encourage us, either through 
pressure to the FTC to change things where our lack of 
expertise might actually end up doing more harm than good on 
both sides.
    But I tell you one thing that I think many of us feel, 
especially those who support small business across the board, 
small or large businesses, is the whole basic principle of 
legal certainty. Businesses will not get capital investment in 
areas if there is no legal certainty, in the inner city, maybe 
brownfields redevelopment; in a small franchisee it might be 
lack of legal certainty, the cause of lack of a moving target 
on a contractual signing with the franchisor, which I find just 
really ridiculous that a franchisor would offer a contract to a 
franchisee that could change. I mean, how in the heck does 
someone have any legal certainty for a period of time to try to 
project capital investments, costs and a return on their 
investment?
    So I would encourage, as we move to push the FTC to move 
forward in promulgating a rule or amendments to the rule, that 
if we don't fall into the same problem as identified in the 
1979 rule based upon 1960 experience, that we don't promulgate 
2002 amendments to the 1979 rule that are based upon 1980 
experiences, because we don't want to be back here in 15 years.
    So let me ask, are the abuses that are identified in some 
of the reports, we have got--the Attorney General's office, you 
probably get abuses.
    Mr. Cantone. We hear about abuses all of the time, but I 
don't think we hear about abuses to the extent they exist in 
the marketplace for some of the same reasons that we have 
talked about. I go out and speak to franchisees and hear 
stories about renewal problems or encroachment issues, but for 
many reasons franchisees don't complain to my office because 
they don't complain to the FTC because they realize we don't 
have jurisdiction to handle these issues.
    We haven't had a complaint about encroachment in our office 
for more than 5 years, but we hear time and again that it is a 
real issue.
    Mr. Shimkus. Which would be the example of the chairman's--
with the university. That would be an encroachment issue.
    Mr. Cantone. Absolutely. I hear from Ms. Kezios, from her 
and her members. So we realize it is an issue, it is a concern. 
And a lot of franchisors do not provide protected territory, 
which leaves franchisees open to the possibility that they 
could have a competing franchise across the street from their 
same franchisor.
    Mr. Shimkus. Mr. Rizer, so you are operating as a 
franchisee for a Dairy Queen, but the International Dairy Queen 
could, in essence, locate within a geographical area that you 
are now serving?
    Mr. Rizer. If they wanted. There are ways. Yes. Now, 
regardless of----
    Mr. Shimkus. Regardless of what contractural arrangements 
you have made in the past.
    Mr. Rizer. Right. There are ways. You asked a question 
about FTC complaints. I am surprised that you have any. I am a 
small businessman. I am independent. I go in, and I work my 
store. I normally get up at 4:30 in the morning to go to work, 
and my day doesn't end until 3, 4 in the afternoon, and I am in 
bed at 7. Great. I don't have time to call and complain to 
someone else, let alone the government, which I really don't 
see as being something to solve my problems.
    Most Dairy Queen franchisees that I know are independent. 
They take care of their own problems, and until yesterday, I 
didn't know I could complain to the FTC. As a matter of fact, 
we went through a lawsuit with International Dairy Queen in the 
1990's, early 1990's, and we did have our executive director 
and counsel go to the FTC and the Justice Department with 
complaints, and we were told, well, you have an action here for 
a lawsuit, sue them.
    Well, we weren't looking to sue. We wanted a good 
relationship with our franchisor, but we were told we had to 
sue to get any redress to our grievances. We did that, and we 
won, in our opinion, won the lawsuit and money to go along with 
it.
    It was ultimately a settlement. We are happy with that. But 
we didn't want to sue them, we want to get along.
    Mr. Shimkus. This UFOC--and I can't--I don't remember the 
acronym. I would like it up. Do you have great hopes that that 
will be helpful if the FTC offers that as part of the 
amendments to the 1979 rule? Does everyone agree with that?
    Mr. Cantone. Absolutely. The UFOC is far superior. As a 
matter of fact, we have been talking about these required 
disclosures, like the list of franchisees and other issues. We 
are talking about the UFOC. If you look back at the FTC rule, 
for example, that is why in Kentucky you only have a list of 
Kentucky. The UFOC requires 100 franchisees in the State and 
surrounding States. That is just one example.
    The UFOC is far superior to the FTC disclosure document, 
which really is kind of an anachronism in 2002.
    Mr. Shimkus. When do you think--since the FTC, which you 
all heard me talk about has been 5 years in promulgating the 
amendments to the rule, and, as we also observed, they really 
weren't very assertive in actually giving a parameter when we 
might see some timeframe in these amendments, when do we need 
amendments to the rule? Does everyone agree--yesterday. I mean, 
everybody is shaking their head, yes.
    Mr. Wharton, you are not?
    Mr. Wharton. Well, I think we need it as soon as possible.
    Mr. Shimkus. Not yesterday?
    Mr. Wharton. Well, I think, Congressman, the most--they 
need to do it as quickly as possible. Most franchisors are 
complying with the UFOC now. That is exactly what they do 
because it is permitted by the FTC.
    Mr. Shimkus. Most of our experience is based on--like Mr. 
Rizer's Dairy Queen or McDonald's or that. Yours is different 
in that extent. Give us your basic business.
    Mr. Wharton. It a stamping business. Basically what 
happens, instead of--one major distinction would be instead of 
having multiple franchise owners in a particular market area, 
we will normally have one franchise owner in a market area. And 
that franchise owner has one or two offices at most, because 
what we are doing is providing people either temporary staffing 
or permanent staffing in a market area.
    Mr. Shimkus. It is a little different business model.
    Mr. Wharton. It is. That is one of the things you have to 
think about. There are all kind of different business models 
out there, because if you line it all up with the fast food or 
the hospitality industry, it doesn't quite work. But we need it 
as quickly as possible. But currently, as a practical matter, 
most of the franchisors--I say most; it is probably about 99 
percent of the franchisors are using the UFOC, which went 
through substantial revision in the mid-1990's to bring it up 
to date.
    Mr. Shimkus. Chairman, if I can finish the panel then--I 
know I am overtime.
    Ms. Kezios.
    Ms. Kezios. Yesterday would be nice. You should be aware, 
though, that there are regional franchisors who choose to sell 
just in the States where there are no State regulators reading 
documents. Everybody in the franchise industry knows that if 
you are starting up and you are young, go to a State where you 
don't need to file a document, where nobody is going to read 
it. So there is no one looking over anybody's shoulder in those 
States.
    Mr. Shimkus. That is why the FTC rule is important, to 
cover those States where there is no compliance or no 
reporting.
    Ms. Kezios. That is why the FTC rule is still ineffective 
in those States.
    The amendments are needed quickly.
    Mr. Wieczorek. Yes. The FTC should take action as soon as 
possible. Franchisors have been waiting for themselves to get 
the new documents prepared and done. But, as Mr. Wharton said, 
the UFOC has been in place, the new UFOC has been in place, for 
the last 7 or 8 years. That is largely what the new FTC rule 
will require. So most franchisors are already doing it. But 
there are some additional improvements that the FTC is trying 
to do.
    Mr. Rizer. It needs to be done as soon as possible. It 
would be nice if it was yesterday, but until we have a private 
right of action, what good is it to continue to make rules that 
aren't enforced or used? It make no sense.
    Mr. Shimkus. I will end by saying there is a perfect 
example of how business and associations or States, through the 
UFOC, respond, how much more rapidly than the Federal 
Government if they have had this now for 7 years, and we have 
been waiting 5 years for amendments to a rule that we still 
don't have a timeline from that is going to probably marry 
closely the UFOC. That is just my frustration. And with that I 
yield back.
    Mr. Stearns. Thank you.
    I am going to ask one question, then I think each Member 
would like to ask additional questions. If you could have your 
way, which two amendments to the FTC rule would you suggest? 
And I will just go from right to left with Mr. Cantone. And 
would these amendments help with the postsale relationship 
problems?
    Mr. Cantone. Mr. Chairman, are you talking about amendments 
that are not being considered right now?
    Mr. Stearns. Yes.
    Mr. Cantone. In my personal opinion, Mr. Chairman, there 
are two issues that spring to mind, and they may or may not be 
able to be addressed in the rule. But one of the issues that we 
see time and time again is that franchisors frequently are able 
to require that any meaningful dispute resolution be held in 
the State of the franchisor, and for small franchisees who 
might live States away from the franchisor, it basically stops 
that franchisee from going forward and doing any dispute 
resolution.
    The way that they do that is by requiring arbitration, and 
under the Federal Arbitration Act as we view it, the location 
for the arbitration can be at the option of the franchisor. 
Maryland, for example, has a requirement in our franchise law 
that litigation be--about the franchise offering must take 
place in Maryland. That is a protection to franchisees to allow 
them dispute resolution in Maryland. That only applies to 
litigation. Most franchisors require disputes be held through 
arbitration, and under the current state of the law, they can 
require that that arbitration take place where the franchisor 
is located. That, I think, is a really, really big problem. The 
franchisees cannot even start to resolve disputes through 
litigation or arbitration or whatever. That basically prevents 
them from going around and resolving any of the problems they 
have.
    The other issue that I have is with the fact that the 
current--and this might be just a theoretical problem that 
might have not have an answer to, is franchising covers such a 
huge number of industries, from hotel franchises at one point 
to the other end of the spectrum, janitorial franchises, which 
really in most cases are the type of franchise directed to 
people who have less resources for getting a lawyer or 
resources even to review the document. You held up that 
document. The most complex franchise disclosure documents and 
disclosures are in this industry, and most frequently they 
require a very small investment.
    That, I think, is an issue that really is a problem in 
franchising today as we know it, and I think it is a problem 
that needs some resolution. I don't know that the FTC rule as 
currently drafted or State laws really address the fact that 
there are some real problems out there in one segment of the 
industry.
    Mr. Stearns. Mr. Wharton.
    Mr. Wharton. I guess I would say that the--the proposal to 
confirm it to the UFOC is probably the most important piece. I 
think that the UFOC is a simplified--somewhat simplified 
document. It has all of the information. I think it was during 
the mid-1990's when it was revised one--it was done with both 
the regulators and the franchisors and the franchisees 
participating in the process to ensure that information that 
was really important was in that document; and that it was done 
further in plain English, that was another change that was made 
to it.
    While it seems complex, I think that the documents at least 
uniformly touch all of the areas that they need to touch, and 
that, in itself, if the prospective owner will go through the 
document with an advisor, doesn't have to be an attorney, but 
some independent advisor that is a professional, to help them 
analyze the opportunity, I think that will actually go to help 
solving a lot of the postsale problems, because the--if both 
sides understand, if both parties to the transaction understand 
what is in there and what the issues are going to be and what 
the problems are going into the arrangement, then I think that 
you solve a lot of the postsale problems. Not all. It is a 
long-term relationship. It is like a marriage. I think there 
are always going to be disputes. The question is, how do you 
work through those. And most franchisors try and work with 
their franchise communities to work through those issues.
    Ms. Kezios. Other than the two issues that I brought up 
already, the problem with the documents is that they are legal 
works of art, so it is going to be very difficult to ever 
figure out the rules of the game how the documents are written 
out, based on how the corporate franchisor lawyers are writing 
them. For example, talk about a postsale issue encroachment, 
you need to have language as clear as this in the document. You 
have no protected area. Your franchisor, without compensation 
to you, may place another store in a location that may 
completely erode your profitability. That needs to be put in 
there. Plain English.
    Litigation. The franchisor lawyers, they are hiding the 
ball on the litigation. You asked the question, Mr. Rush, what 
kind of litigation is required in the document? The litigation 
where franchisors are suing the franchisees is not required in 
the document now. It should be required. Pending litigation is 
not required in the document. So if I am looking at a Dunkin' 
Donuts contract offering circular, there may be five pieces of 
litigation. They have got 200 lawsuits pending. Wouldn't you 
like to know what is going on with those other 200 lawsuits 
that the franchisor has filed against franchisees? This is what 
I mean by hiding the ball.
    These guys know how to write these contracts. There is no 
way that you are going to be able to figure out--Mr. and Mrs. 
Smith, who are taking their life savings to invest in these 
businesses, are not going to be able to figure that out at the 
outset. These are not contracts of equal bargaining power. 
There is no equal bargaining power in a franchise relationship.
    Mr. Wieczorek. I am one of those lawyers that Susan is 
referring to. I really don't know how to hide the ball, and our 
clients don't try to hide the ball, I can assure you. The most 
important thing is--something that Congressman Rush pointed 
out--is that these documents are big and intimidating 
documents, and we are not--as lawyers drafting them, we are not 
trying to draft them so that they are intelligible, we are 
drafting them because that is what the rules require us to say. 
These are all disclosures and documents that are attached to it 
that are required by the law, and we have no way around that.
    So I agree that there should be some effort on the part of 
government to figure out ways to make the information more 
accessible, more readable. And certainly someone should have a 
lawyer represent them or a financial advisor represent them 
when they are buying a franchise. But even then it would still 
be helpful to have the document available on a more accessible 
basis.
    Mr. Rizer. Well, I am not a lawyer, and so I don't know 
what to suggest, other than what I have suggested in my 
statement. The private right of action would be very helpful, 
and it doesn't matter whether there is State court or Federal 
court. If there is no cause for an action, I am not going to 
bring one. So that wouldn't be a burden, as you mentioned.
    Mr. Stearns. All right. Mr. Rush, any additional?
    Mr. Rush. Yes.
    Mr. Rizer, I want to continue where you just stopped off. 
If you had a private right of action, what would that do for 
franchisees that can't--what power or what influence, 
bargaining power, would that give to franchisees that they 
don't have right now? And let me just also ask, you indicated 
that you were advised to sue your franchisor, and you didn't 
really want to do that. If you had the right of private action, 
just having that there, would that help--you think would help 
influence the franchisor to come in and make some kind of 
settlement with you earlier rather than having to go through 
the process?
    Mr. Rizer. Yes. Always having a big stick to wave around is 
a wonderful thing. You don't have to use it. It is just that 
they know that it is possible. They will be able to come and 
talk to you. At the present time there is no reason. As far as 
I am understanding, all of this is about the companies, 
franchisors, complying with the rules of the FTC. And a private 
right of action, if I am harmed because they didn't follow the 
rules, if they lied or were deceptive, if they said I could 
buy--back in the 1990's it was that they said that I could buy 
from anybody, but that wasn't the case, well, to me that is 
lying to me.
    Mr. Rush. So having a private right of action could kind of 
balance the--the territory, give you some kind of common area 
of discussion, common influence.
    Mr. Rizer. It would give them a reason to come talk.
    Ms. Kezios. Private right of action is the only market 
force that franchisors will pay attention to. When the 
corporate franchisor lawyers worked in the 1970's to hobble the 
promulgation of the rule, when the rule's promulgation was 
inevitable, they took out the private right of action.
    FTC staff are on the record back then--this is from the FTC 
staff comments in 1979: The Commission believes that the courts 
should and will hold that any person injured by a violation of 
the rule has a private right of action against the violators 
under the Federal Trade Commission Act as amended in the rule.
    Now, that didn't happen, but FTC staff has been on the 
record since then saying they fully expected that it would 
happen, and it never happened.
    Mr. Rush. Mr. Wieczorek.
    Mr. Wieczorek. I would like to respond to that. In Mr. 
Rizer's case, obviously they brought an action because they had 
the right to bring an action. They had a big stick to use. And 
right now franchisees do have big sticks to use. They have 
lawsuit rights for breach of contract, for common law fraud, 
for violation of State law, FTC acts, for violation of State 
franchise disclosure laws. I don't think any franchisee 
believes that they are hobbled now in terms of having rights to 
bring suit.
    So no other trade regulation rule that is administered by 
the FTC has a private right of action. The courts created--
Congress created the FTC as an expert in the area of the issues 
covered by the various rules. So when the FTC decides that a 
company violated the FTC rule, they are exercising their expert 
objective decisionmaking power that it was a violation. If you 
threw it out to the courts, who knows what is going to happen? 
The rule would be interpreted 1,000 different ways, and that is 
a problem.
    Mr. Rush. Let me ask you, Mr. Wieczorek, the IFA, how many 
members do you have?
    Mr. Wieczorek. IFA has about 1,000 franchisor members, 
about 30,000 franchisee members, and about 200 supplier 
members.
    Mr. Rush. So you represent----
    Mr. Wieczorek. Both sides, yes.
    Mr. Rush. And, Ms. Kezios, how many members does the AFA 
have?
    Ms. Kezios. Fifteen thousand.
    Mr. Rush. Do you represent any franchisors?
    Ms. Kezios. No, we don't I might add that for 40 something 
years the IFA didn't represent franchisors either. It was upon 
our growth in 1993 that the IFA opened its arms all of a sudden 
to franchisees as members, strictly to co-op our efforts.
    Mr. Rush. What about suppliers?
    Ms. Kezios. No, we don't.
    Mr. Stearns. Thank you.
    I am going to thank all of you for participating, 
sincerely. And we have had a lively discussion. In a democracy 
that is what is important. You get your views out. You don't 
always agree. But I think this hearing has been very helpful. I 
think it is one of the few hearings on franchisors and 
franchisees we have had in Congress, so I am pleased to chair 
it. I want to thank Mr. Rush for his attendance, and so, again, 
thank you all, and the subcommittee is adjourned.
    [Whereupon, at 11:55 a.m., the subcommittee was adjourned.]

```