Making a Case for Mandatory Item 19 Disclosure
The US Securities Act of 1933 (the Securities Act) requires that the filing of a registration statement with the Security and Exchange Commission and the distribution of a prospectus in connection with the Initial Public Offering for investors must contain certain financial statements and other financial information regarding the issuer’s financial condition and results of operations. The objective of these regulations was twofold; first, after the Great Depression reduce the possibility of high risk investments as much as possible and second, set standards that would require companies that went public to meet those standards. Although investors in companies have little or no impact on company operations, those who invest in a franchise play a significant role in the day to day operations, of their franchise and thus the overall franchise system. However, those individuals considering a franchise opportunity who seek franchisee financial information have been limited to the 60% of franchisors that provide a financial performance representation under Item 19.
The voluntary nature of a franchisor FPR leaves an opening that only a start-up franchisor should be able to exercise. Over the past several years, the increase in FPR’s has been the result of competitive pressures placed upon particular franchisors. However, the franchise industry and thousands of prospective franchisees should not have to rely competitive factors as the catalyst for more FPR’s. Although the FTC is in the process of establishing guidelines for Item 19 disclosures there is no movement to eliminate the voluntary provision. As far as I can recall, franchisors have always had the contractual right to obtain financial information from their franchisees. It remains a mystery as to why some franchisors gather this information and don't use it in a meaningful way. One excuse for not making a FPR mandatory is that franchisees would submit unrealiable financial information. The answer is that using revenue, gross margin and expense data for an FPR should be sufficent. Moreover, franchisees submitting information should make a representation that the information is according to their knowledge accurate. It shouldn't be necessary to have an ironclad representation.
In 2014, Mike Sheehan, an attorney who is currently working for Sallie Mae wrote an article on the importance of requiring mandatory Item 19 disclosure. He believes that there can qualifiers for new franchise systems such as years franchising, etc. that could address a certain objection that’s been raised.
I have little doubt that mandatory Item 19 disclosures would enhance the ability of franchise candidates to better evaluate franchise opportunities and cause unhealthy franchise systems to either improve or encourage their exit from franchising and thus enhance the quality of our industry. I attached a link to Mike Sheehan’s article that helps to support my position on mandatory FPR’s. Click to read it.