Comments to the Commentary: Fisher Zucker’s Response to NASAA
As we mentioned in a previous blog post, the North American Securities Administrators Association (“NASAA”) published a notice of request for public commentary regarding financial performance representations (“FPRs”) that franchisors disclose within Item 19 of their franchise disclosure documents (“FDDs”). The request by NASAA was a follow up to a similar request they made a year ago. In both requests, NASAA has sought feedback from the public regarding a proposed set of guidelines dictating what franchisors are permitted to present in Item 19 of their FDDs. The importance of these guidelines cannot be overstated, as Item 19 is the one place where franchisors can provide financial performance information to its franchisee prospects. For emerging franchisors without established brands, Item 19 disclosures can be the key to selling those first few units and generating system growth.
Generally speaking, the proposed guidelines restrict a franchisors’ ability to present financial data by prohibiting certain types of FPRs entirely and requiring disclosure of additional information in conjunction with other types of FPRs. Last year, we also submitted comments and we were pleased to see that NASAA incorporated some of our recommendations into this year’s revised commentary. However, the 2016 proposed guidelines still contained a number of troubling restrictions that limit emerging franchisors’ ability to present relevant financial data to prospective franchisees, create compliance difficulties by requiring franchisors to supplement actual results with less reliable projections (or, alternatively, hurt prospective franchisees by depriving them of crucial information), andtouch upon issues better addressed through additional disclosures and mandatory statements.
First, NASAA requires that a franchisor using company-owned data to show gross profit or net profit must adjust these figures to incorporate differences between company-owned and franchised locations. This requirement effectively calls for franchisors to make speculative projections by taking reliable historic financial data and qualifying it based on financial and operational differences of their various outlets. In our comments to the NASAA, we have criticized this requirement because it has the potential to discourage a franchisor from making an FPR in such an instance due to the inherent risk that franchisors could later be held accountable to these speculative projections. This issue raises particular concern for emerging franchisors who may only have company-owned data and therefore have no other options for presenting profits.
Another problematic requirement in the proposed guidelines is the rule that a franchisor disclosing data from its best performing outlets must also include data from its lowest performing even when a franchisor also presents system-wide data. While the intentions behind this requirement are understandable in terms of preventing misleading data, the requirement itself is excessive. When a franchisor presents its best performing outlets, it is also required to present system-wide averages, which must be accompanied by the median of the numbers in the average as well as the highest and lowest numbers in the range. To then, on top of that, require results from the lowest performing outlets is both redundant and unnecessary.
In addition to these and other items, we also re-iterated an argument from last year that was not fully adopted by NASAA. Specifically, the proposed guidelines provide that franchisors cannot present FPRs based on a subset of locations if they have fewer than ten operational locations, even if there is a reasonable and objective basis for doing so. We believe that this is discriminatory against new and emerging franchisors, who may have a very good reason for presenting a subset but would be prohibited from doing so due to the size of their system.
We hope that other members of the franchise community also submitted comments so that NASAA can better understand the importance and also the potential negative impacts of its proposed guidelines. We will await an update from NASAA in the upcoming months and we believe that, similar to last year, NASAA will be receptive to our well-intentioned comments and will revise their guidelines accordingly.Back