Since the inception of the FTC Franchise Rule (16 C.F.R. § 436.1), the FTC has brought more than two hundred enforcement actions under the rule. The FTC has been particularly successful at stopping fraudulent business sales related to the sale of vending machines and rack displays. However, the FTC Franchise Rule has been unsuccessful at stopping many work-at-home and pyramid marketing schemes.
The FTC Franchise Rule seeks to prevent fraud by requiring franchisors and other business opportunity sellers to disclose material information to purchasers before consummating the sale. Under the Rule, a seller of a business, including a franchise, is legally obligated to disclose the following prior to a sale: 1) The seller’s name, address, principal place of business, type of business, and the name of parent company, if any; 2) The seller’s background, litigation history, and bankruptcy history; 3) The offer’s terms and conditions; 4) a statistical analysis of existing outlets of the business; whether company-owned or franchised; 5) The name, address, telephone number of the one-hundred closest franchise outlets; and 6) Audited financial statements.
In addition, the seller must disclose certain specific financial information if it chooses to make any representation regarding projected financial performance of franchises. There are also detailed disclosure requirements in connection with making earnings claims that must be followed if you’re a franchisor.
FTC Franchise Rule Exemptions
Many MLM‘s and direct sellers are exempt from the requirements of the FTC Franchise Rule. In order to minimize the compliance costs for smaller businesses, there are exceptions to the FTC Franchise Rule, as follows:
i. “Minimum Threshold Exception.” The rule does not apply to business opportunities which the buyer does not need to make a payment of $500 or more within six months of purchase;
ii. “Wholesale Exception.” Voluntary purchases of reasonable amounts of inventory at wholesale prices do not count toward the $500 minimum threshold;
iii. “Training and buy-back Exception.” Finally, the Franchise Rule does not apply if the buyer is merely paying for training or if the buyer and seller agree that the seller will buy back and resell goods assembled by the buyer.
There are also 15 states with disclosure and registration responsibilities for offering franchise type opportunities.
The FTC Franchise Rule does not cover most work-at-home schemes because of the training and buy-back exception. The rule does not apply if the purchaser is able to sell the goods he/she purchases back to the business opportunity seller. In addition, the wholesale exception often exempts these schemes because most purchasers are required to pay large amounts to buy “supplies.” For instance, the Franchise Rule does not usually apply to business opportunities such as craft assembly and envelope stuffing. As you can imagine, most Work-at-Home sellers require that the purchaser must purchase the materials necessary to assemble products up-front.
Some unscrupulous sellers assure buyers that once they assemble the products or stuff the envelopes, the seller will then repurchase the products to sell to the general public. Of course, the seller misrepresents the market for these goods and suggests that the goods will likely be repurchased. That usually never happens and purchasers are left with worthless products. These practices are still deceptive under Section 5 of the FTC Act. In fact, the FTC has recently gone after and even shut down envelope-stuffing operations, do-it-yourself Internet business set up kits and other websites falsely promising guaranteed jobs or that the consumer could make substantial income working home based jobs.
The bottom line is that you should avoid conducting scams as they can be prosecuted generally under the FTC Act for deceptive practices or potentially under the FTC Franchise Rule.