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A Matter for the State? An attorney discusses the government's place in franchising.

By Devlin Smith

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

Occasionally a bill is presented in the Senate that would give the federal government further regulatory powers over franchising. Currently, the government oversees disclosure, but many of these proposed laws would allow the government to actually regulate franchisee/franchisor relations.

When fraud is rampant, such intervention can be a good thing. But is franchising in a place where it needs more strident government oversight? According to David J. Kaufmann, a New York City-based attorney with 25 years of franchise law experience in both the government and private sectors, the answer is no.

Franchise Zone: Should franchising be self-regulated or government-regulated?

David J. Kaufmann: I don't think there's much of a contest between government regulation in franchising and self-regulation in the franchise arena. Experience has proven over and over again that self-regulation is far more efficient, achieves its goals in greater depth and has better results for all concerned, both franchisors and franchisees, than government regulation. The experience I'm referring to is the securities industry.

When the securities markets really began to heat up in the 1910s and 1920s, and when fraud started to enter the securities markets in the 1920s, the states started to regulate the securities industry on a state-by-state basis. Finally, the federal government became involved in the late 1920s. The federal government very wisely determined that the best way to regulate the securities industry was not to regulate it directly but rather to let the securities industry regulate itself, reserving government intervention for only the most flagrant cases of fraud or illegality. The New York Stock Exchange, American Stock Exchange and NADSAQ are referred to as self-regulatory organizations. Each securities exchange in this country has a constitution and rules that all member firms abide by, and over the past 70 years, self-regulation in the securities industry has proven remarkably successful. While there are occasional horrific stories, such as Enron, considering the billions of dollars traded on our nation's securities exchanges each day, the number of lapses, errors and abuses that take place are relatively miniscule.

It's a wonderful model for franchising to emulate, and, in fact, franchising has begun to emulate it. There is an entity of some of our nation's largest and most prestigious franchisors called the National Franchise Council. The NFC years ago partnered with the Federal Trade Commission to deal with franchisors who commit violations of the FTC Franchise Rule. The state of New York also entered into similar arrangement with the NFC, while other states are participating in the NFC's Alternative Law Enforcement Program. Under this program, if a franchisor has committed a violation of disclosure laws, the prosecuting authority will give that franchisor a choice to either be prosecuted or go to the NFC for franchise law compliance retraining, oversight of the subject franchisor's disclosure or mediation to solve any disputes with franchisees.

It's nice to get some sort of a sanction against an errant franchisor, but at the end of the day, the franchisor going forward may not know how to comply with the law. The option of sending the errant franchisor to the NFC for compliance retraining achieves a greater good. What it does is, first, protect those franchisees who may have been harmed through the mediation option, and, second, make sure prospective franchisees receive accurate disclosure. This is the first move toward franchise self-regulation.

[Government] regulation of the franchise relationship would call upon the federal government to enter into not one industry, but into multiple industries of which the government knows little. For instance, would there be one rule for the guest lodging sector, which could require investments of $50 million, and the smaller franchises, where the investment is $5,000? There is no one-size-fits-all approach that would ever work in franchising, because franchising is not an industry, it's merely a method of distributing products and services.

The simple fact of life is, despite certain radical franchisee advocates claiming there's rampant abuse in the franchise arena, there's no evidence of anything of the sort. In fact, last year the U.S. General Accounting Office came out with a report saying the government could discern no hard evidence of any such abuses in the franchise arena. There are lots of franchisees in this country making a very, very good living, who have no complaints at all about their franchisors. I'm not going to suggest there is never any problem in franchising--there are occasional errant franchisors, and they are adequately dealt with by the state and federal government, who have done a remarkable job of keeping the franchise arena very clean from crime. In the face of no documented abuses in the franchise arena, and the franchise industry pretty well taking care of its own problems and complying with the disclosure law regime that has been in place now for 30 years, I don't see any need, or reason, for the government to enter the fray and begin regulating franchise relationships.

Why is it OK for the government to regulate disclosure?

All legitimate franchisors believe that telling the truth upfront about the relationship is a very healthy thing for both parties. The greatest cause of unrest among franchisees is false expectations. There are, unfortunately, too many prospective franchisees who believe they're going to get wealthy from the franchise in question, and go in with that expectation, and if that doesn't come true, get very angry and tend to resort to litigation. Full and complete disclosure negates this possibility. Full and complete presale disclosure makes sure prospective franchisees know in advance what to expect from the franchise. They are given the information necessary to make an informed investment decision, including the names and addresses and phone numbers of every franchisee in the system, all in an effort to ensure the prospective franchisee has expectations that are real world and not pipe dreams.

What role should the government play in franchising?

I think the government should continue its diligent efforts to ensure that full pre-sale disclosure transpires in all instances, and also should continue to pursue those franchisors who fail to comply with pre-sale disclosure laws and regulations, while affording relief to franchisees who may have been injured by any failure to abide by franchise disclosure laws.

What should franchisors be doing to regulate themselves?

I think they're doing it now. What they should be doing is assisting the federal government in ensuring full compliance with state and federal franchise disclosure laws, rules and regulations.

How can the federal government and franchisors work best together?

The federal government and the state governments and the franchisors have been working remarkably well and in great harmony over the past three decades. There is no disconnect between the government on one hand and the franchisors on the other. To the contrary, there has been a commonality of interest: one, keep the marketplace clean of fraud; two, abide by pre-sale disclosure laws, rules and regulations; three, make sure the government continues to keep the marketplace clean by chasing down those franchisors who deliberately and flagrantly violate the disclosure laws.

What role can franchisees play?

These statutes, laws and regulations and the NFC's law enforcement programs are all geared to helping franchisees, and giving them avenues of redress should they be harmed. There's not much for franchisees to do except enjoy the fruits of these federal and state laws that are designed to protect them.

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