Vigilante Justice: Is Franchise Sales Registration Overly Examined?

We now have all of the requirements of the FTC's Amended Franchise Rule being implemented.

All franchisors should be complying with the Amended Rule's disclosure requirements, and most franchisors who have sales activities in the registration states are now doing battle with the state examiners, as they test the procedures and borders of the revised disclosure requirements. That brings to mind two topics of discussion, one of which I will address below, and the other (a look at the overall system for regulating franchise sales disclosure) I will save for another column.

Today's subject: How are the state examiners reacting to the changes in franchise disclosure/registration?

Answer: I can't respond to this question from the examiner's viewpoint, but from this practitioner's standpoint, not well.

Let me say at this point what I like to refer to as the pledge of allegiance: I have utmost admiration for the state administrators and their examiners and other staff members. They are people of integrity, and I have always felt that even though we don't always agree with how they handle their job responsibilities, they are sincerely committed to their job, which is to protect the public from franchise fraud.

That having been said, I sense that at the moment they are making life very difficult for those of us who desire to sell franchises, or to assist our clients in so doing, consistent with the law, but in an economical, efficient manner.

It has been my perception, and one I have learned is shared with many of my compadres, that the state examiners have become ever more vigilant in their franchise disclosure document review--and in many eyes they have become overzealous. To the extent that practitioners are not complying with the spirit of the law and regulations, this increased vigilance is good. But it seems that many of the comments on filings that I and others have recently received go beyond the pale. A few examples:

• Recently on the ABA Listserv, one lawyer commented that an examiner had asked him to substitute something for the term "franchisee"--both in the FDD and in the form of franchise agreement. According to this source, the term "franchisee" was too legalistic.
• My firm has recently received comment letters asking that the lead-ins to Items 2, 6, and 7 be deleted. For example, the examiner objected to the fact that our Item 7 opened by saying that the following chart described the initial investment that a franchisee is likely to make if it purchases the franchise. Absent this introduction, all the prospective franchisee sees is a chart labeled "Initial Investment," or something to that effect. I contend that the approach we used, and which I have seen used for almost three decades, provides a better road map to the franchisee as to what he or she is about to read, and is in no way is confusing or misleading. In fact, it is just the opposite.
• One of my colleagues tells me that an examiner demanded a franchisor to disclose the fact that it had--and the amount of--its negative net current assets. Only it didn't have any. Getting this point across to the examiner took great persuasion, according to my colleague.

Based upon what I have seen on the ABA Listserv, I am sure I could create an active blog that addressed solely these kinds of problems.

I would encourage the NASAA Franchise and Business Opportunities Project Group to keep close watch on this problem in the following months, and to encourage practitioners to submit to them situations where they perceive that examiners have become unnecessarily strict or have simply missed the mark, so that the Projects Group can have a better feel for the types and extent of these problems, and take corrective measures. The state administrators I have spoken with have shown a genuine concern as to whether there is a significant problem regarding the registration process, and want to be in a position to address it, if it does in fact exist.

If I have misjudged the extent of this problem, I offer my apologies in advance to the staffs who handle franchise registrations. However, I don't think I am off the mark.

Rupert Barkoff is a partner in Kilpatrick Stockton LLP's Atlanta office, where he heads the firm's Franchise Practice. He is a past chair of the American Bar Association's Forum on Franchising, and Co-Editor-in-Chief of the ABA's publication, Fundamentals of Franchising. His current "nighttime job" is collecting stories on good and bad customer service, which will be used as the basis for a book in upcoming years. Go to www.anecdatabook.com and submit one or several stories.