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FTC Business Opportunity Rule

FTC Business Opportunity Rule

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Published by: Lani Rosales on Mar 22, 2012
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76816
Federal Register
/Vol. 76, No. 236/Thursday, December 8, 2011/Rules and Regulations
1
43 FR 59614 (Dec. 21, 1978).
FEDERAL TRADE COMMISSION16 CFR Part 437
RIN 3084–AB04
Business Opportunity Rule
AGENCY
:
Federal Trade Commission(FTC or Commission).
ACTION
:
Final rule.
SUMMARY
:
The Commission is adoptingfinal amendments to its TradeRegulation Rule entitled ‘‘DisclosureRequirements and ProhibitionsConcerning Business Opportunities’’(‘‘Business Opportunity Rule’’ or‘‘Rule’’). Among other things, theBusiness Opportunity Rule has beenamended to broaden its scope to cover business opportunity sellers not covered by the interim Business OpportunityRule, such as sellers of work-at-homeopportunities, and to streamline andsimplify the disclosures that sellersmust provide to prospective purchasers.The final Rule is based upon thecomments received in response to anAdvance Notice of ProposedRulemaking (‘‘ANPR’’), an Initial Noticeof Proposed Rulemaking (‘‘INPR’’), aRevised Notice of Proposed Rulemaking(‘‘RNPR’’), a public workshop, a Staff Report, and other information discussedherein. This document also contains thetext of the final Rule and the Rule’sStatement of Basis and Purpose (‘‘SBP’’),including a Regulatory Analysis.
DATES
:
The provisions of the final Rulewill become effective on March 1, 2012.
ADDRESSES
:
Requests for copies of thefinal Rule and the SBP should be sentto Public Reference Branch, Room 130,Federal Trade Commission, 600Pennsylvania Avenue NW., Washington,DC 20580. The complete record of thisproceeding is also available at thataddress. Relevant portions of theproceeding, including the final Rule andSBP, are available at
FOR FURTHER INFORMATION CONTACT
:
Christine M. Todaro, (202) 326–3711,Division of Marketing Practices, RoomH–286, Bureau of Consumer Protection,Federal Trade Commission, 600Pennsylvania Avenue NW., Washington,DC 20580.
SUPPLEMENTARY INFORMATION
:
The finalRule modifies the interim BusinessOpportunity Rule in two significantways. First, the final Rule contains anexpanded definition of ‘‘businessopportunity’’ aimed at extending thescope of the Rule to businessopportunities previously not covered,such as work-at-home programs.Second, although the final Rule’s scopeis broader than the interim BusinessOpportunity Rule, the compliance burden is reduced. Specifically, incontrast to the extensive disclosurespreviously required, the final Rule nowrequires that business opportunitysellers provide prospective customerswith a substantially simplified andstreamlined one-page disclosuredocument. The final Rule also addsaffirmative prohibitions onmisrepresentations and omissions, aswell as disclosure requirements for salesconducted in Spanish and otherlanguages besides English.
Statement of Basis and Purpose
Key Terms and Abbreviations UsedThroughout This Statement of Basis andPurpose
‘‘Amended Franchise Rule’’ refers to theamended Franchise Rule published at 72FR 15444 (Mar. 30, 2007) and codified at16 CFR 436.‘‘ANPR’’ refers to the Trade Regulation Ruleon Franchising and Business OpportunityVentures: Advanced Notice of ProposedRulemaking, 62 FR 9115 (Feb. 28, 1997).‘‘Initial Proposed Disclosure Document’’refers to the original version of theDisclosure Document that was proposed inthe INPR in 2006.‘‘INPR’’ refers to the Initial Notice of Proposed Rulemaking for the BusinessOpportunity Rule, 71 FR 9054 (Apr. 12,2006).‘‘Interim Business Opportunity Rule’’ refersto the Business Opportunity Rule, codifiedat 16 CFR 437 that is currently in effect andis the subject of these amendmentproceedings.‘‘IPBOR’’ refers to the Initial ProposedBusiness Opportunity Rule, which wasproposed in the INPR in 2006.‘‘Macro Report’’ refers to Macro International,Inc.’s report to the FTC on the DisclosureForm, available at
‘‘Original Franchise Rule’’ refers to theoriginal Franchise Rule published at 43 FR59614 (Dec. 21, 1978).‘‘RNPR’’ refers to the Revised Notice of Proposed Rulemaking for the BusinessOpportunity Rule, 73 FR 16110 (Mar. 26,2008).‘‘RPBOR’’ refers to the Revised ProposedBusiness Opportunity Rule, which wasproposed in the RNPR in 2008.‘‘Staff Report’’ refers to FTC staff’s
Staff Report to the Federal Trade Commissionand Proposed Revised Trade RegulationRule
(16 CFR Part 437). The Staff Reportis available at
‘‘Workshop’’ refers to the June 1, 2009, publicworkshop held in Washington, DC, todiscuss the proposed Disclosure Documentand other aspects of the BusinessOpportunity Rule.‘‘Workshop Notice’’ refers to the
FederalRegister
Notice announcing the Workshop,74 FR 18712 (Apr. 24, 2009).
I. Introduction
A. Overview of the Franchise Rule and the Evolution of the Interim BusinessOpportunity Rule
1. The Franchise RuleOn December 21, 1978, theCommission promulgated a TradeRegulation Rule entitled ‘‘DisclosureRequirements and ProhibitionsConcerning Franchising and BusinessOpportunity Ventures’’ (the ‘‘OriginalFranchise Rule’’), to address deceptiveand unfair practices in the sale of franchises and business opportunityventures.
1
The Original Franchise Rulecovered, in a single Code of FederalRegulations part, both franchises andcertain business opportunity ventures.With franchises, the franchisee sellsgoods or services that are associatedwith the franchisor’s trademark, and thefranchisee is subject to significantcontrol by, or receives significantassistance from, the franchisor. Thefranchisee typically distributes goods orservices supplied by the seller or anaffiliate and receives accounts orlocations in which to conduct the business. By contrast, businessopportunities often do not involve atrademark. Vending machines or rackdisplay routes are typical examples of  business opportunities. Based upon theoriginal rulemaking record, theCommission found that unfair anddeceptive practices were widespread inthe sale of franchises and businessopportunities, causing serious economicharm to consumers.The Commission adopted the OriginalFranchise Rule to prevent unfair anddeceptive practices in the sale of franchises and business opportunitiesthrough pre-sale disclosure of specifieditems of material information. Thepurpose of the Original Franchise Rulewas neither to regulate the substantiveterms of a franchise or businessopportunity agreement nor to regulatethe relationship between the seller andthe buyer. Rather, it was to ensure thatsellers disclose material information toprospective buyers. The OriginalFranchise Rule was posited on thenotion that a fully informed prospective buyer can determine whether aparticular offering is in his or her bestinterest.The Original Franchise Rule requiredextensive disclosures on a score of specified topics, such as, informationabout the seller; the business background of the seller’s principalsand their litigation and bankruptcyhistories; the terms and conditions of 
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76817
Federal Register
/Vol. 76, No. 236/Thursday, December 8, 2011/Rules and Regulations
2
60 FR 17656 (Apr. 7, 1995).
3
62 FR 9115 (Feb. 28, 1997).
4
64 FR 57296 (Oct. 22, 1999).
5
Id.
6
The industry term ‘‘business format franchise’’specifically refers to franchises in whichfranchisees operate under a common trademark orother commercial symbol and are required toadhere to the specific business format or method of doing business prescribed by the franchisor.Business format franchises are commonly called‘‘franchises’’ by the general public, and the twoterms are used interchangeably here.
the offer; statistical analyses of existingfranchised and company-owned outlets;information about prior purchasers,including the names and addresses of atleast 10 purchasers nearest theprospective buyer; and audited financialstatements.The Commission recognized thatrequiring these extensive disclosureswould likely impose significantcompliance costs on businesses covered by the Original Franchise Rule. Ittherefore sought to strike the proper balance between prospectivepurchasers’ need for pre-sale disclosureand the burden imposed on thoseselling business ventures covered by theRule. To achieve this balance, theCommission limited the scope of theOriginal Franchise Rule’s coverage inthree significant ways.First, the Original Franchise Rulecovered only those opportunities thatrequired a purchaser to make a paymentof at least $500 within the first sixmonths of operation. In transactionswhere a purchaser may incur highfinancial losses if the seller withholdsmaterial information, the benefit forprospective purchasers of the OriginalFranchise Rule’s pre-sale disclosurerequirements outweighs the sellers’ costto make those disclosures. By contrast,when the investment required topurchase a business opportunity iscomparatively small, prospectivepurchasers face a relatively smallfinancial risk. In such circumstances,compliance costs may outweigh the benefits of pre-sale disclosure.Therefore, the Original Franchise Ruledid not reach opportunities that chargedlower fees.Second, the ‘‘inventory exemption’’excluded certain types of paymentsfrom the Original Franchise Rule’s $500minimum cost threshold. The‘‘inventory exemption’’ is the franchiseindustry’s shorthand term for theCommission’s determination that, as amatter of policy, voluntary purchases of reasonable amounts of inventory at bonafide wholesale prices for resale do notcount toward the required thresholdpayment. An important consequence of this policy determination was toeliminate from Original Franchise Rulecoverage many pyramid marketing plans because purchasers of such planstypically do not make a requiredpayment of or exceeding $500, butinstead make voluntary purchases of inventory in reasonable amounts and at bona fide wholesale prices for resale.Third, in addition to franchiseopportunities, the Commission focusedthe Original Franchise Rule on the typesof business opportunities that the recordshowed were likely to result insignificant consumer injury, such asvending machines, rack displays, andsimilar opportunities, which frequentlywere sold through deceptive conduct. Afeature common to these types of opportunities was the promise of assistance in securing locations oraccounts. Thus, the Commissionincorporated this characteristic into theOriginal Franchise Rule’s definitionalelements to ensure coverage of demonstrably injurious schemes. Otherforms of assistance that businessopportunity sellers frequently offer—such as training and the buy-back andresale of goods assembled by thepurchaser (an element of many craftassembly opportunities) did not bring a business opportunity within the scopeof the Original Franchise Rule’scoverage.In addition to these limits on thescope of the Original Franchise Rule’scoverage—driven by balancingprospective purchasers’ need for pre-sale disclosure against the burdenimposed on business opportunitysellers—another aspect of the OriginalFranchise Rule’s language furtherlimited the scope of coverage.Specifically, the Original Franchise Ruleprovided that a business opportunitywas covered only if the purchaser of theopportunity sells goods or servicesdirectly to end-users other than the business opportunity seller. The effectof this limitation was to exclude manywork-at-home opportunities—such asenvelope stuffing and craft assemblyventures—from Original Franchise Rulecoverage. In those opportunities, thepurchaser typically performs work forthe seller or produces various goods forthe seller, who then purportedlydistributes them to end-users.In 1995, as part of its systematicreview of FTC rules, the Commissionpublished in the
Federal Register
arequest for comment on the OriginalFranchise Rule to determine itscontinued effectiveness and impact.
2
 Based upon the comments receivedduring the rule review, the Commissiontentatively determined to retain theOriginal Franchise Rule, but soughtadditional comment on possibleamendments. To that end, in February1997, the Commission published anANPR, seeking comment on variousissues, including whether theCommission should separate thedisclosure requirements for businessopportunities from those for franchises.
3
 Based upon comments responding tothe ANPR, the Commission found thatthe Original Franchise Rule continuedto serve a vital purpose and that pre-saledisclosure was necessary to protectpurchasers of franchises and businessopportunities from fraudulent anddeceptive sales practices. At the sametime, however, the Commission agreedwith the overwhelming view of thecommenters who suggested that thereare material differences betweenfranchises and business opportunitiesand that these two types of distinct business arrangements require separatedisclosure approaches. For example,many of the Original Franchise Rule’spre-sale disclosures, in particular thosepertaining to the structure of the parties’relationship, do not apply to the sale of most business opportunities becausethose sales typically involvecomparatively simple contracts. Inaddition, the Commission recognizedthat the Original Franchise Rule’sdetailed disclosure obligations maycreate barriers to entry for legitimate business opportunity sellers.
4
 Accordingly, in 1999, the Commissionannounced its intention to conduct aseparate rulemaking proceeding for business opportunity sales.
5
 2. The Interim Business OpportunityRuleMuch of the information revealed bythe Commission’s regulatory review of the Original Franchise Rule highlightedthe differences between franchises and business opportunity ventures, and thedistinct regulatory challenges presented by these two types of offerings—thatfranchises typically are expensive andinvolve complex contractual licensingrelationships, while businessopportunity sales are generally lesscostly and involve comparatively simplepurchase agreements that pose less of afinancial risk to purchasers. Based onthe record amassed during the reviewproceeding, the Commission concludedthat the Original Franchise Rule’sextensive disclosure requirementsimposed unnecessary compliance costson both business opportunity sellersand buyers, and determined to bifurcatethe Original Franchise Rule into twoseparate parts—one covering the sale of  business format franchises
6
and one togovern the sale of businessopportunities. Accordingly, in theANPR, the Commission solicited
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76818
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/Vol. 76, No. 236/Thursday, December 8, 2011/Rules and Regulations
7
62 FR at 9115. In response to the ANPR, theCommission received 166 written comments. Thestaff also held six public workshops on the issuesraised in the comments, three of which specificallyaddressed business opportunities.
8
72 FR 15444 (Mar. 30, 2007).
9
For example, references to ‘‘franchisor’’ and‘‘franchisee’’ used in the Original Franchise Rulewere changed in the interim Business OpportunityRule to ‘‘business opportunity seller’’ and ‘‘businessopportunity purchaser,’’ and the Original FranchiseRule’s definition of ‘‘franchise’’ was changed to‘‘business opportunity.’’
See id.
10
73 FR 16111, 16112 (Mar. 26, 2008).
11
71 FR 19054 (Apr. 12, 2006).
12
The INPR also specified the process theCommission would follow in amending theBusiness Opportunity Rule. Pursuant to theCommission’s Rules of Practice, 16 CFR 1.20, theCommission determined to use a modified versionof the rulemaking process set forth in section 1.13of those Rules. Specifically, the Commissionannounced that it would publish a Notice of Proposed Rulemaking, with a 60-day commentperiod, followed by a 40-day rebuttal period. Inaddition, pursuant to Section 18(c) of the FTC Act,the Commission announced that it would holdhearings with cross-examination and rebuttalsubmissions only if an interested party requested ahearing. The Commission also stated that, if requested to do so, it would contemplate holdingone or more informal public workshops in lieu of hearings. Finally, pursuant to 16 CFR 1.13(f), theCommission announced that staff would issue aReport on the Business Opportunity Rule (‘‘Staff Report’’), which would be subject to additionalpublic comment. 71 FR at 19079–80.
13
Multi-level marketing is one form of directselling, and refers to a business model in which acompany distributes products through a network of distributors who earn income from their own retailsales of the product and from retail sales made bythe distributors’ direct and indirect recruits.Because they earn a commission from the sales theirrecruits make, each member in the MLM networkhas an incentive to continue recruiting additionalsales representatives into their ‘‘down lines.’’
See
Peter J. Vander Nat & William W. Keep,
Marketing Fraud: An Approach to Differentiating Multilevel Marketing from Pyramid Schemes,
21 J. Pub. Pol’y& Marketing 140 (Spring 2002).
14
Promoters of business opportunities were ableto evade coverage under the Original FranchiseRule and the interim Business Opportunity Rule bypricing their offerings opportunities below $500,the monetary threshold of coverage.
15
71 FR at 19057.
16
Id.
17
71 FR at 19091.
18
71 FR at 19068.
19
Comments responding to the INPR are availableat
References to INPRcomments are cited herein as: Name of thecommenter-INPR (
e.g.,
Avon-INPR).
20
Thousands of comments were form letterssubmitted by participants in various MLMprograms. 73 FR at 16113.
21
Numerous letters came from individuals havingnegative experiences with various MLMs. 73 FR at16113 n.37.
22
73 FR at 16113.
23
Id.
at 16110.
comment on several proposedregulatory modifications, including thecreation of a separate trade regulationrule governing the sale of businessopportunities.
7
 Subsequently, the Commissioncompleted all procedural stepsprescribed by Section 18 of the FTC Actto finalize the Amended Franchise Rule,along with a Statement of Basis andPurpose, in March 2007.
8
At that time,the Amended Franchise Rule—nolonger covering businessopportunities—was codified at Part 436in Title 16 of the CFR. The OriginalFranchise Rule with all definitionalelements and references regarding business format franchising deleted, wasretained and redesignated as Part 437.Part 437 was titled the ‘‘interimBusiness Opportunity Rule.’’
9
Theinterim Business Opportunity Rulecontained no new substantivedisclosure requirements or prohibitions,and in all material respects wassubstantially identical to the OriginalFranchise Rule. Until the final Rule becomes effective, Part 437 governssales of non-franchise businessopportunities.
10
 
B. Rule Amendment Proceedings
1. Initial Notice of Proposed Rulemakingand Initial Proposed BusinessOpportunity RuleIn 2006, having determined that aseparate business opportunity rule wasnecessary, the Commission publishedan Initial Notice of ProposedRulemaking (‘‘INPR’’), announcing itsintention to proceed with its proposalfor a separate Business OpportunityRule (the ‘‘initial proposed BusinessOpportunity Rule’’ or ‘‘IPBOR’’).
11
TheINPR proposed to amend the interimBusiness Opportunity Rule by updatingit, streamlining it, and expanding itsscope of coverage.
12
The IPBORcontained an expansive definition of ‘‘business opportunity’’ thatencompassed business opportunitiespreviously covered by the OriginalFranchise Rule as well as work-at home,medical billing, and multi-levelmarketing (MLM)
13
operations. It alsoeliminated the $500 threshold for Rulecoverage.
14
 Streamlining the interim BusinessOpportunity Rule and tailoring it to fit business opportunities (as opposed to business format franchises) has been aprimary focus of this proceeding. Boththe Original Franchise Rule and theinterim Business Opportunity Rulerequire extensive disclosures coveringover twenty specified topics. In theINPR, the Commission recognized thatthese extensive disclosure requirementsentail disproportionate compliancecosts for sellers of comparatively low-cost business opportunity ventures.
15
 Therefore, the Commission proposed tomitigate the compliance burden bysimplifying and streamlining thedisclosure requirements.
16
 Specifically, the INPR proposed aone-page business opportunity pre-saledisclosure document (the ‘‘initialproposed disclosure document’’) withonly six required material disclosures.
17
 The initial proposed disclosuredocument was intended to provideprospective purchasers with essentialmaterial information they could use inmaking a purchase decision. The INPRproposed to require sellers to use theexact form and language set forth by theCommission and to include informationregarding (1) the seller; (2) earningsclaims; (3) legal actions involving theoffered business and its key personnel;(4) the existence of cancellation orrefund policies; (5) the number of cancellation or refund requests; and (6)references.
18
 In response to the INPR, theCommission received more than 17,000comments, the overwhelming majorityof which came from individuals activein the MLM industry.
19
MLMcompanies, their representatives andtrade associations, as well as individualparticipants in various MLM plans,expressed grave concern about the burdens the IPBOR would impose onthem and urged the Commission toexclude them from the scope of theIPBOR, to implement various safeharbor provisions, and to reduce therequired disclosures.
20
The Commissionalso received approximately 187comments, primarily from individualconsumers or consumer groups, in favorof the IPBOR.
21
Only a handful of comments came from non-MLMcompanies and industry groups,expressing various concerns aboutobligations that the IPBOR wouldimpose upon them.
22
None of thecomments addressed the form of theinitial proposed disclosure document.2. The Revised Notice of ProposedRulemaking and Revised ProposedBusiness Opportunity RuleBased on an extensive review of thecomments received in response to theINPR and the Commission’s lawenforcement history, the Commissionissued a revised Notice of ProposedRulemaking (‘‘RNPR’’) on March 28,2008, that set forth a revised proposedRule (the ‘‘Revised Proposed BusinessOpportunity Rule’’ or ‘‘RPBOR’’) thatwas more narrowly tailored than theIPBOR.
23
 In the RNPR, the Commissionrecognized that there were two mainproblems with the IPBOR’s breadth of coverage. First, the IPBOR would haveunintentionally swept in numerouscommercial arrangements, including
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