Responding to a request by Congress, the U.S. General Accounting Office (GAO) examined various issues associated with the regulation of franchises and business opportunity ventures and prepared a report on its findings. The new report builds on the GAO's earlier report addressing enforcement of the Franchise Rule by the Federal Trade Commission (FTC) and discusses various matters pertaining to franchise relationship issues. This special Franchise Handbook Series looks at the findings of the new report.

As part of our report to Congress on Franchise Rule enforcement, the General Accounting Office (GAO) requested comments from the FTC chairman and the Small Business Administration (SBA) acting administrator on a draft of the report.

The FTC chairman responded in a letter, saying that our report correctly recognized the nature, focus and jurisdictions of FTC's enforcement activities relating the Franchise Rule.

He also noted that based on comments we provided during the course of our review, FTC has revised its procedures to document the reasons for closing franchise and business opportunity investigations that result in no further legal action. The FTC chairman was silent on FTC's potential involvement in the study mentioned in the Matter for Congressional Consideration.

The acting administrator for the SBA also responded in a letter, stating that SBA has a longstanding record of assisting franchisees through financial assistance, technical assistance and business counseling.

The acting administrator stated that SBA's office of Advocacy has conducted studies on franchising activity and noted that, as discussed in our draft, the Office of Advocacy is mentioned as being able to conduct such a study if additional funds were appropriated for this purpose. However, he also pointed out that the franchise data necessary to support such a study does not presently exist-the data are either dated or limited in scope-and would need to be created before a study could be conducted. We recognize that there could be barriers or limitations to obtaining data on the extent and nature of franchise relationship problems, as well as cost and time considerations. These are factors that should be considered when weighing the pros and cons of conducting such a study.

We also recognize that federal agency involvement in this study will likely require that additional funds be appropriated. However, such a study could provide a better framework for considering whether there is a need for federal franchise relationship legislation, especially since the absence of such data makes it difficult to determine the extent and nature of franchise relationship problems.

To summarize the key points of this report, the GAO found that FTC has focused most of its Franchise Rule enforcement resources on business opportunity ventures because, according to FTC staff, problems in this area have been more pervasive than problems with franchises.

For example, from January 1993 through June 1999, FTC reported that it received 3,680 business opportunity and franchise complaints, 92 percent of which involved business opportunities and the remaining 8 percent franchises. From its analysis of complaints and other case generation activities, FTC opened a total of 332 investigations from 1993 through 1999, most of which pertained to business opportunities.

Also, from 1993 through 2000, FTC brought 162 cases to court for violations of the Franchise Rule and/or section 5 of the FTC Act. Of these, 88 percent involved business opportunities, and the remaining 12 percent pertained to franchises. For each of the 162 cases brought to court, FTC obtained some type of relief, including injunctions, civil penalties or monetary redress for investors.

FTC staff told the GAO that limited resources and other law enforcement priorities prevented FTC from pursuing every meritorious complaint and investigation involving franchises and business opportunities. They said that FTC generally pursued those cases it believed would have the greatest likelihood of financial recovery for franchise and business opportunity purchasers or the greatest deterrent effect for potential violators.

GAO told Congress that it could not determine why FTC closed many of the business opportunity and franchise investigations it had opened. "Our review of the 79 files for investigations that FTC closed from 1997 through 1999 for which it took no further legal action showed that, while supervisory approval had been obtained for closing each investigation, only two of the 79 files documented the reasons why the investigations were closed," GAO reported.

"FTC staff told us that it is likely these investigations were closed either because of a lack of sufficient evidence of wrongdoing or the subject was out of business," it added. "However, FTC did not have any documentation to support their explanation because FTC did not require staff to document why franchise and business opportunity investigations were closed."

Based on GAO's work, FTC has since revised its procedures to require staff to document the reason(s) for closing franchise and business opportunity investigations that result in no further legal action. FTC uses various means, such as annual law enforcement meetings and periodic conference calls, to communicate and coordinate its franchise and business opportunity enforcement activities with the states.

Responses to GAO's survey of regulatory officials in the nine states that have both franchise and business opportunity disclosure laws indicated that FTC's current communication and coordination activities have been focused primarily on business opportunity issues.

According to FTC staff, data FTC has collected, while limited, suggest that franchise relationship problems are isolated occurrences rather than prevalent practices, GAO told Congress.

In the absence of such data, opinions varied as to the need for a federal statute to regulate franchise relationships, GAO reported. FTC staff told GAO that the data they have collected are not sufficient to enable them to make an informed opinion about the need for federal franchise relationship legislation.

Franchise trade association officials had divergent views on the need for a federal statute. For example, officials from one association that represents franchisees told GAO that a federal statute is needed to address franchisees' lack of bargaining power in the franchise relationship and because existing laws do not effectively address relationship issues.

In contrast, officials from another franchise association-one that represents both franchisors and franchisees-told GAO a federal statute is not needed because franchise relationship issues are matters of contract law. It was their feeling that those issues should continue to be addressed at the state level, and that pre-sale disclosure is the best way to protect prospective franchisees.

GAO suggested that if Congress believes it needs empirical data before considering franchise relationship legislation, it could commission a study that would do two things.First, it would design and implement an approach for clollecting empirical data on the extent and nature of franchise relationship problems. Second, it would examine franchisor and franchisee experiences with existing remedies for resolving disputes.

The chairman of the FTC and the acting administrator of the Small Business Administration (SBA) were provided a draft of the GAO report for comment.

The SBA acting administrator said that SBA has used its limited resources to perform studies of discreet franchise issues in the past, but it implied that additional resources would be needed to gather data and study franchise relationship issues, GAO told Congress.