In Praise Of The State Franchise Regulators
I must be becoming a curmudgeon. In recent Viewpoint columns, I have taken potshots at the FTC and my fellow franchise lawyers. So far, the state franchise regulators have for some reason been below my radar screen. Why?
Over the course of my career, the state regulators have been both the bane of my existence and, to be quite blunt, a significant source of income. As a practitioner, I have had various run-ins with the regulators, just as many of the readers of this column have.
At times, I have felt they were unreasonable, they were not being practical, and they were implementing statutes and regulations that were, to a significant degree, unnecessary. Is there really a need for each of the true registration states to be reviewing virtually the same UFOC? Do eleven reviews truly benefit prospective franchisees? At the same time, these regulations and statutes create a need for legal services, which many of us have been able to use to put food on our families' tables.
Many of us have, indeed, taken potshots at the state regulators. It is interesting to read the banter on the A.B.A. Forum on Franchising Listserv, where many of my colleagues have, diplomatically, expressed disappointment about the positions taken by some of the state regulators. Behind the scenes, I have even heard derogatory remarks made (and, I will confess, that I have made some myself) about some of the individual regulators who comment from time to time.
I don't want to wax sentimental, and I don't want to appear as a brown-noser, but I think it important that the franchise bar, and the franchise community, recognize that there is a human side to these individuals. They are hard-working, devoted to their jobs, and interested in doing what is right, even though their definition of "right" may show a perspective different from how we practitioners may think of that term.
I have had the privilege of serving two stretches on the Advisory Committee to NASAA's Task Force on Franchising. The task force is composed of regulators from several states and monitors franchise regulation. Its advisory committee has about a dozen members, almost all lawyers, who assist in this monitoring process and comment upon projects that the task force may undertake. Exposure to the task force has given me the opportunity to meet many of the state regulators, both in a non-adversarial business setting (i.e., not in the course of representing a client) and outside of the meeting room in social settings.
The sincerity and good faith of the regulators as to their job performance should be beyond question. I recall my first registration application, for a real estate franchisor, where I went head on with Joan McCollister (a name few probably remember) of Michigan (then a registration state). It was brutal, with the situation being fueled by my client, who felt political pressure would bring the Michigan Department of Securities to its knees. He was, of course, wrong. When I met Joan in person several months later, I saw her human side-she was not the monster that my client envisioned simply because she took hard lines about several of the disclosure items in my client's proposed Uniform Franchise Offering Circular.
The same holds true today. My office has butted heads with many of those regulators who currently are charged with protecting prospective franchisees. I still don't like it, but I am more sensitive today to the pressures that they are under, and more likely to commiserate with them than to feel outraged.
The state franchise regulators-from the top of each department on down to the examiners-are really in a quite difficult position. They are in day-to-day contact with their adversaries-the lawyers and their clients who need to have their franchises registered quickly and efficiently.
At the same time, they rarely (almost never?) have involvement with their true constituency-prospective franchisees. Prospective franchisees don't really have an advocate, other than the state regulators. And yet, the line of communication between the two is absent. Only when a former prospect who has become a franchisee finds himself or herself in trouble is the state regulator put in touch with this constituent.
And, of course, there are the political considerations that are always lurking behind the state franchise regulators' shoulders. If the regulators are too lenient on franchisors, they are subject to criticism when a registered franchisor goes down. If they are too strict, they are, again, criticized, and too strict enforcement can lead to dissolution of the registration process. (Does the word "Michigan" come to mind?) And then there are always budgetary issues. Are the bureaus responsible for monitoring franchise registrations self-funding? If not, a state legislature or governor may decide to make the bureau a target for extinction.
Why now do I sing praises about the state regulators? Although most of our dealings with the state officials are on registration matters, I recently had the experience of dealing with these officials on the other, less pleasant side of their activities. I was approached by a company which had made earnings claims, in writing, outside of their disclosure documents. We were faced with the dilemma of having either to wait for the states to inform the client of its improper acts-something which might never occur-or to take the high road and voluntarily report the violations and let the cards fall where they may. We chose the latter course.
In a recent article authored by Len Vines of St. Louis, a private practitioner, and Gina Bishop, a former franchise examiner in the Illinois Attorney General's office, with a little assistance from me, we reported that one of the key factors that a state considers in deciding how to deal with an enforcement situation is whether the franchisor voluntarily reports the violation [Damage Control for Violations of Registration and Disclosure Obligations, 24 FRANCHISE LAW JOURNAL 191 (Winter 2005)]. This statement was made based upon formal and casual comments made to Len or Gina in preparing the article for publication. My client's situation gave me the chance to test the veracity of this statement.
Having taken the high road, we (my client and I) found the state officials to be true to their word. Admittedly, this was not the case of the franchisor who had intentionally defrauded numerous prospective investors, taken the money and run, where the attitude of the state regulators would certainly have been more hostile. While the franchisor was registered in six states, only eight sales had been made where improper earnings claims had been involved. Thus, the level of damage was not severe, with many of the violations having fallen in the "no harm, no foul" category.
Although the state administrative agencies could have imposed significant fines, strong-armed my client into consent decrees, and required harmful disclosures, for the most part, the state administrators approached the problem before them quite practically.
Three states required rescission offers with respect to four of the sales (none of which was accepted). No state required the offense to be reported in my client's UFOC, and only two imposed fines-one for $500 and one for $2,000.
All but two states required my client to execute an agreement, similar to a consent decree, requiring my client not to repeat the violation, but none required judicial approval of the agreement. Two required that my client attend a program on sales compliance, which I like to refer to as "summer school," but that was certainly a more attractive alternative to defending against a lengthy and expensive enforcement proceeding. In short, the states worked with my client in trying to achieve an appropriate result. For that, I and my client were thankful.
Though this story may sound maudlin, there is a point behind it. The state officials are burdened with significant responsibilities. We need to respect that, and if you do, you will find that the states will work with you to solve your problems.
At the same time, I hope that the state regulators will keep in mind that we lawyers have a responsibility to our clients to represent them "zealously." If the current regulatory scheme is to function effectively, it requires cooperation from both sides, as well as an understanding of the needs of both. So long as this occurs, franchise sales regulation will still impose a burden on us, but this imposition will be manageable. I don't like dealing with 11 to 14 states, but when it comes to state franchise registration statutes, be thankful there are not 50!
By Rupert M. Barkoff
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