The Use of Subsets in a Financial Performance Representation in your Franchise Disclosure Document
As most in the franchise community are likely aware, on October 1, 2015, the North American Securities Administrators Association’s Franchise and Business Opportunity Project Group (NASAA) released for internal and public comment a proposed franchise commentary on financial performance representations (the “FPR Commentary”). And, although the public comment period has since ended, members of the NASAA committee have recently revealed that the FPR Commentary will be revised and open for public comment for a second time in the upcoming months. Although the FPR Commentary discusses many different aspects of a financial performance representation, one such aspect is the use of subsets. The general limitation on the use of subsets relies on the familiar rule that the subsets must (a) be accurate, (b) have a reasonable basis for their inclusion, and (c) not be misleading.
While this three-part test seems simple enough at first glance, is it possible to have a subset that is both accurate, yet misleading? Also, it is important to remember that there are additional rules that NASAA intends to require when a franchisor uses subsets. Specifically, a franchisor may not simply include only the best outlets in the system, and a franchisor with fewer than ten substantially similar company-owned outlets and franchised outlets that have been operational for at least one year may not include a subset of these outlets. It seems NASAA believes that it is clear that in at least both of those scenarios there is a tendency for the FPR to be misleading to a prospective franchisee, even if the data presented was accurate and the appropriate footnotes were included (and assuming that such footnotes were actually read by the prospect, which may or may not be a safe assumption). Regardless, testing whether an FPR is “misleading” seems to be a subjective test and the thought of different state examiners (whether in the same state office or as between the states) interpreting it differently will likely strike fear in the eyes of most franchise attorneys.
For example, how is a new franchisor supposed to create their first FPR if they have fewer than ten outlets? It seems that the only option is to include all outlets because the use of subsets is no longer allowed. But, one could argue that including all ten could be misleading as well. What if some of the outlets are in a historic location and some are not? What if some of the operators operate less than full-time but do deviate enough to be a default of the franchise agreement? What if some outlets report their gross sales in a different point-of-sale system than the rest? There are many reasons to exclude an outlet from an FPR in order to make the subset included more similar to the franchised business the prospect may eventually open – i.e. to be less misleading. So, which is the lesser of the two evils – including all ten outlets or deciding to not include an FPR at all? The answers to these questions seems quite unclear. Perhaps the best option is to wait for the revised FPR commentary and revised second round of public comments. Stay tuned.Back