Franchise fraud is defined by the United States Federal Bureau of Investigation as a pyramid scheme.
Franchise fraud in U.S. federal law
The FBI website states:
In the United States, franchising is regulated by a complex web of franchise rules and franchising regulations consisting of the Federal Trade Commission Franchise Rule, state laws, and industry guidelines.
The most recent version of the FTC Franchise Rule was in 2007, is printed in.
The FTC franchise rule specifies what information a franchisor must disclose to a prospective franchise business as a franchise opportunity in a document named the Franchise Disclosure Document (FDD).[2][3]
- "pyramid schemes — also referred to as franchise fraud or chain referral schemes — are marketing and investment frauds in which an individual is offered a distributorship or franchise to market a particular product. The real profit is earned, not by the sale of the product, but by the sale of new distributorships. Emphasis on selling franchises rather than the product eventually leads to a point where the supply of potential investors is exhausted and the pyramid collapses."[1]
Ponzi schemes
Similar to a pyramid scheme, a Ponzi scheme involves paying existing investors in a nonexistent enterprise with the funds from new investors thus creating the illusion of a "profit". One of the key differences between a Ponzi scheme and a pyramid scheme is that in a Ponzi scheme, investors are paid using the money from future investors. While in a pyramid scheme, the original schemer recruits other investors to recruit others (and so on) where new recruits pay the person who recruited them for the right to participate or perhaps sell a certain product.
Means of committing franchise fraud
Franchisors that practice franchise fraud will attempt to pressure a franchisee leaving the franchise system to sign a non-disclosure agreement, confidentiality agreement or a gag order.[4] The gag order allows franchise misrepresentation by preventing prospective new franchisees learning important details about the churning franchise. Unfortunately, the Federal Trade Commission Rule and the State Franchise Disclosure Documents that govern the sale of franchises appear to enable franchisors to withhold negative facts concerning the performance of the franchised business plan from new buyers of franchises and to disclaim that the franchisors have promised anything in the way of success and profits in the written disclosure document and the binding, and generally non-negotiated, franchise agreement.[5]
Franchise fraud law in the U.S. state by state
California
California Franchise Investment Law,[8] begins at section 31000 of the California Corporations Code.[9] Part 1 lists the definitions of the California Franchise code. Part 2 is the Regulation Of The Sale Of Franchises. There are three chapters, 1) Exemptions, 2) Disclosures, and 3) General Provisions.
Under chapter 2, section 31125 the following exists
If a franchisor in California keeps less than 25% of former California franchisees (not nationwide franchisees), per year, under a Gag order, there is no violation. The modification agreement can have a clause in the document stating that it was "signed voluntarily".
Part 3 of this code describes Fraudulent and Prohibited Practices. Chapter 1 describes Fraudulent practices.[10] Chapter 2 describes Prohibited practices.[11]
See also
- American Association of Franchisees and Dealers
- Franchise termination
- Censorship
- Chilling effect (law)
- Fear mongering
- Franchise Disclosure Document
- Franchising
- Rollovers as Business Start-Ups
- The Franchise Rule
- Frivolous litigation
- Legal threat
- SLAPP
- U.S. Securities and Exchange Commission
Further reading
Books and papers
Newspapers
References
- FBI — Common Fraud Schemes. Fbi.gov. Retrieved on 2010-12-06.^
- Franchise and Business Opportunities | BCP Business Center. Business.ftc.gov. Retrieved on 2010-12-06.^
- FTC Issues Updated Franchise Rule. Ftc.gov. Retrieved on 2010-12-06.^