New 2/24/07

In April 2006, the Federal Trade Commission issued a proposed rule that expands the FTC’s regulation of sellers of business opportunities. The rule is intended to protect consumers from bogus business opportunities.

In 1995, the Commission conducted a regulatory review of the Franchise Rule to ensure that it continues to serve a useful purpose. One issue that the Commission explored was the application of the Franchise Rule to the sale of business opportunities. Specifically, the Commission noted that although the Franchise Rule applied to certain business opportunities, it lacked a clear definition of the term “business opportunity” and asked whether such a definition should include business opportunities not covered by the Franchise Rule, such as “multilevel marketing, seller assisted market plans, work-at-home plans, and certain distributorships and licenses.” At the conclusion of the Rule Review, the Commission determined to retain the Franchise Rule with modifications designed to harmonize it better with state franchise regulations, and to seek additional comment on whether to address the sale of business opportunities through a separate, narrowly tailored new trade regulation rule.

Two important types of fraudulent or deceptive opportunities that would fall within the proposed Rule’s coverage are work-at-home schemes and pyramid marketing schemes.

The proposed definition of “business opportunity” would specify coverage by the rule would be triggered by either:

  • the making of an earnings claim (NOT limited to guarantees of a level of earnings; or that the purchaser will earn at least as much as his or her investment) or
  • the promise of business assistance by a seller.

Triggering application of the rule

The proposed definition of “business opportunity” contemplates that business opportunity sellers will solicit prospective purchasers to enter into new businesses, as opposed to merely soliciting purchasers for goods or services. In contrast, a typical retailer may sell various goods that could be used in a business, and may even recommend that its goods be used in a particular business, but the retailer does not ordinarily promote the business itself.

Business assistance

One definitional element is the term “business assistance ” which means ” the offer of material advice, information, or support to a prospective purchaser in connection with the establishment or operation of a new business.” The Commission intends to ensure coverage of those business relationships that involve more than the ordinary sale of goods or services to existing businesses. The proposed definition lists 5 illustrative, but not exhaustive, examples. The common thread is that the seller promotes his or her expertise in operating the business or in providing a market for the goods or services the purchaser sells to the public, or in ensuring compensation promised to the purchaser, thereby reducing the purchaser’s financial risk:

  • Location Assistance (including the promise to provide locations “for the use or operation of equipment, displays, vending machines, or similar devices on premises neither owned nor leased by the purchaser”, substantially similar to the analogous provision in the current Franchise Rule);
  • Account Assistance (“providing, or purporting to provide, outlets, accounts, or customers, including, but not limited to, Internet outlets, accounts, or customers, for the purchaser’s goods or services”, similar to the current “account assistance” provision of the Franchise Rule, but updated by specifying that outlets, accounts, or customers include those on the Internet”, including the offer to provide Web sites or online shopping malls where the seller’s products can be sold);
  • Buy-Back Assistance (“buying back, or purporting to buy back, any or all of the goods or services that the purchaser makes, produces, fabricates, grows, breeds, modifies, or provides”, not including the offer to buy back inventory or equipment needed to start a business);
  • Payment Assistance (“tracking or paying, or purporting to track or pay, commissions or other compensation based upon the purchaser’s sale of goods or services or recruitment of other persons to sell goods or services”, including multi-level marketing.);
  • Other Advice or Training Assistance (“advising or training, or purporting to advise or train, the purchaser in the promotion, operation, or management of a new business, or providing, or purporting to provide, the purchaser with operational, managerial, technical, or financial guidance in the operation of a new business.”)

The proposed “business assistance” definition does not include “a written product warranty or repair contract, or guidance in the use, maintenance, and/ or repair of any product to be sold by the purchaser or of any equipment acquired by the purchaser.” This provision is necessary to distinguish ordinary support and warranty commitments that many manufacturers or retailers offer in connection with the sale of their products from the more extensive assistance that characterizes a business opportunity offer.

Changes in the new rule

The proposed Rule has no minimum cost threshold, no inventory exemption, and no limit on scope based on the type of assistance promised as part of the offer. Nor is the coverage of the proposed Rule limited to transactions where the purchaser of the opportunity sells goods or services directly to end-users other than the business opportunity seller. In short, the scope of coverage of the proposed Rule is much broader than that of the Franchise Rule, while the compliance burden is much lighter.

The proposed rule eliminates:

  • the $500 minimum investment exception (consequently the the inventory exception under which voluntary purchases of reasonable amounts of inventory at bona fide wholesale prices for resale do not count toward the required threshold payment no longer applies);
  • many of the 20 disclosures required for franchises (trademarks, for example)

The proposed rule instead requires a 1 page disclosure be delivered 7 days prior to signing a contact, addressing 5 items:

  • whether or not sellers make earnings claims;
  • a list of any criminal or civil legal actions against the seller or its representatives that involve fraud, misrepresentations, securities, or deceptive or unfair trade practices;
  • whether the seller has cancellation or refund policies and such policies’ terms;
  • the total number of purchasers in the past 2 years and the number of those purchasers seeking a refund or to cancel in that time period; and
  • a list of references.

The proposed rule would not require any business opportunity seller to make an earnings claim, but if they did make an earnings claim they would be required to provide additional substantiation in the form of an “Earnings Claims Statement.”

In addition to these disclosure requirements, the proposed Rule would prohibit common deceptive business opportunity sales practices, including among other things, prohibiting business opportunity sellers from misrepresenting:

  1. earnings;
  2. costs or the efficacy, nature, or central characteristics of the business opportunity or the goods or services sold to the purchaser as part of the business opportunity;
  3. cancellation or refund policies;
  4. promised assistance;
  5. the calculation and distribution of commissions, bonuses, incentives, premiums, or other payments from the seller;
  6. the likelihood of finding locations for equipment or accounts for services;
  7. a business opportunity as an offer of employment;
  8. territorial exclusivity or more limited territorial protections;
  9. endorsements;
  10. shills as references;
  11. failing to make promised refunds; and
  12. assigning “to any purchaser a purported exclusive territory encompassing the same or overlapping areas already assigned to another purchaser.”