Company Insider Files Whistleblower Complaint against Domino's Pizza
A corporate insider has filed a well-documented whistleblower report with the U.S. Securities and Exchange Commission (SEC) against Domino’s Pizza, its top-level officers, and various staff members. The complaint states serious allegations against the franchisor related to the circumstances surrounding the company’s misconduct. It lists, “Fraudulent investment scheme; general trading practices; manipulation of security; insider trading; material misstatement or omission in company’s public filings or financial statements; and bribery.”
The crux of the whistleblower report details how Domino’s allegedly forced and orchestrated an unapproved advertising and promotion increase to franchisees in order to pay a $1.85 billion Securitization Transaction (March 25, 2007) with a new partially funded $1.67 billion Securitization (March 15, 2012) debt owed to Securitization entities (pg. 505). The report contends that in return, Domino’s Pizza’s CEO, board members, officers, and employees “could enjoy higher stock prices and dividends through share repurchases and dividend payouts.”
Why should franchisors be concerned about SEC whistleblower reports? Mainly because the Commission repeatedly expresses that it takes these reported allegations seriously in hopes of finding corporate securities fraud. Especially, when it comes from a corporate insider.
The Securities and Exchange Commission states it clearly saying it regards whistleblower complaints by individuals who know of possible securities law violations as the “most powerful weapon in its law enforcement arsenal.” SEC’s website concedes that “through their knowledge of the circumstances and individuals involved, whistleblowers can help the Commission identify possible fraud and other violations much earlier than might otherwise have been possible.” The filed complaints also “allows SEC to minimize the harm to investors, better preserve the integrity of the United States’ capital markets, and more swiftly hold accountable those responsible for unlawful conduct.”
As an introduction, the whistleblower’s extensive report describes how Domino’s Pizza began to "orchestrate" a new round of recapitalization on March 15, 2012 with the placement of certain subsidiaries for a $1.675 billion securitized debt facility. The CEO, officers, board of directors, and employees increased the value of their stock options with stock repurchases and issued a $3 per share special dividend. This was achieved by Domino's Pizza’s full involvement, as the manager of an "Advertising and Promotion Amendment," which was conveyed to franchisees and investors that would become effective and binding as of December 31, 2012, once 100% of franchisees in good standing agreed to the obligations set forth in the amendment.
When Domino’s and its subsidiaries failed to achieve 100% unanimous support from the franchisees by the December 31, 2012 deadline, Domino's then "orchestrated a scheme to exit franchisees and negate the requirements set forth by Domino’s Pizza LLC, and prior Securitization Transactions established with the financial institutions.” The report alleges the Advertising and Promotion Amendment “was the key component in achieving the necessary funding required to be in compliance with Securitization and Financial institutions (pg. 404-411).” The securitization of those assets, which the Advertising and Promotion Amendment was one such asset that was desperately needed by Domino’s Pizza LLC (pg. 167-258).
To clarify, documents show that although Domino’s was required to get 100% votes from franchisees on raising the advertising fee from 5.5% to 6% as part of the securitization, the franchisor fell short of the votes. However, the company publicly stated that they did get the 100% and moved forward with the transaction.
Highlighted below, are key components in describing the whistleblower’s claims that Domino’s concocted a well-orchestrated plan to increase the value of its stock, providing links to franchise and legal documents that show the complexities of the franchisor’s securitization transaction.
Material Misrepresentation on Distribution and Supply Chain Agreements (Securities Exchange Commission, Federal Trade Commission, Investors, Shareholders, and Franchisees)
One segment that stands out in the whistleblower’s report surrounds the pizza company’s distribution and supply chain operation. While Domino’s repeatedly stated in reports, and on earnings and investor calls that franchisees are not required to purchase food and supplies from Domino’s commissary, documents show discrepancies in the franchisor’s statements.
In its January 2013 Franchise Disclosure Document (FDD), Domino’s states that prior to its securitization transaction (pgs. 14 & 15 of 235), its pizza distribution centers sold food and beverage products and equipment to franchisees. But looking back at the 2007 securitization transaction, Domino’s Pizza Distribution assumed the function of selling food and products, which it purchases from Domino’s Pizza LLC and other entities, for resale to franchisees. Although in the franchise disclosure document and SEC filings Domino’s had an optional profit-sharing plan for franchisees from Domino’s commissary for a period of ten years in exchange for a share of its profits of the product distribution center servicing their stores. In public disclosures, if franchisees wanted to terminate their participation, it said they must give one-year notice or immediately refund profit-sharing payments for the previous year. Under internal non-publicly disclosed requirements by Domino’s, a franchisee must purchase food and products or will be terminated, which contradicts public statements and filings (pg. 469 & 470): Under internal non-publicly disclosed requirements by Domino’s, a franchisee must purchase food and products or will be terminated, which contradicts public statements and filings (pg. 469 & 470):
Domino's Pizza LLC., as manager of the Advertising and Promotion Amendment, “has/have no contractual ability within the Securitization Transactions to effectuate "a material decrease in the amount of Collections.” It further states:
"Except with the prior written consent of the Control Party [Midland Loan Services, a division of PNC Bank], the Manager [Domino’s Pizza LLC] shall not (a) take any action (or omit to take any action) (or permit any such action or inaction) with respect to the Managed Assets or (b) permit the termination, amendment or waiver of any provision of any document governing the Managed Assets, other than in accordance with the Management Standard, and then only if the effect of such action, inaction, termination, amendment or waiver, together with the effect of all other previous actions, inactions, terminations, amendments and waivers, with respect to the Managed Asset or to such documents governing the Managed Assets, could not be reasonably expected to result in (i) a material decrease in the amount of Collections other than Excluded Amounts, taken as a whole, (ii) a material adverse change in the nature or quality of Collections other than Excluded Amounts, taken as a whole or (iii) a material alteration in the general assets categories generating Collections other than Excluded Amounts, taken as a whole, or the relative contribution of each such category; provided, however, that this Section 2.10 shall not permit the termination, amendment or waiver of, any provision of any Related Document other than in accordance with the terms of such Related Document."
Domino’s Chief Financial Officer Michael T. Lawton stated on March 08, 2013 at a J.P. Morgan Forum (transcript): "We also operate a value-added supply chain. We think that it's great to have a commissary business and there are 18 centers spread across the U.S.” Then, he states, “. . . Franchisees are not required to buy from us. We have to provide an alternative but virtually all of the stores buy all of their product from our U.S. supply chain"
Domino's Director of Franchise Operations Mark Rudd responded on October 25, 2013 in depositions in a lawsuit (transcript) to a question, “Are you aware of any circumstances amongst the more than 1,000 franchise stores you oversee, where franchisees don't purchase from the Domino's commissary?” He said, “Does a store occasionally go out and buy cherry tomatoes that go on a salad? Yes.” Another question: But generally, the great majority of food products sold by Domino’s franchisees are purchased from the commissary?” Rudd answers, “They are required to purchase them from the commissary.”
Material Misrepresentation on Domino’s National Advertising Fund and Domino's Advertising Increase Amendment (Securities Exchange Commission, Federal Trade Commission, Investors, Shareholders, and Franchisees)
Domino’s also communicated to all national franchisees in January 2013 that the company had taken a big step forward in asking the franchisee system to support a 0.5 percent shift of advertising from local to national. The franchisor believed that shift would provide an extra $25 million of systemwide incremental profit, or an average of $5,000 to the bottom line of each store. Domino’s said in exchange for the franchisees support and amendment of the existing standard franchise agreements, the company agreed to extend standard profit-sharing agreements by five years.
Domino’s states in its 2013 Amendment (attached to the report) that “going forward, all new standard franchise agreements will contain the rolled-up 6 percent national advertising rate.”
DPZ Communications on January 10, 2013 regarding 2013 Amendment (to entire franchisee body) reads as follows:
- Target was 100 percent of system participation and we are moving forward at 99.7 percent
- DPZ will fund the shortfall from the three “no” votes so the ad fund will be 100 percent funded...
- 100 percent of the incremental contribution in 2013 will go to working media
- DPZ will extend all standard SCS profit sharing agreements five years for all “yes” voters, regardless of DPZ performance (contradicts Domino’s Pizza SEC March 15, 2012 Form 8-K pg. 469 & 470)...
- Assuming sufficient support, the new advertising rate will begin January 28, 2013.
Page one states, “The overall results on the surveys reflected the following:
- 50% felt their vote was not voluntary
- 80% felt the amendment required 100% support of every Franchisee to pass
- 80% felt the amendment had a 12-31-12 or before deadline in order to pass"
Page two states, “To ensure the original commitments were honored, the DFA (Domino’s Franchisee Association) was very clear with DPLLC that moving forward on the original amendment was unacceptable since we believed 100% support from every franchisee was needed by December 31, 2012.”
During Domino's Pizza February 24, 2015 Quarter 4 conference call, CEO J. Patrick Doyle stated, “In fact, our franchisees recently voted to increase our national advertising spend going forward, upping it to 6% of top line sales from 5.5%. We think this is a positive vote of confidence from our franchisees. (Page 2)
Jeffrey Andrew Bernstein, Barclays Capital, Research Division, questioned: “And that was approved across the board? So now everybody does the same thing?” J. Patrick Doyle, Domino's Pizza CEO replies, “Yes.” (Page 3)
Material Misrepresentation on Audits, OER (Operation Evaluation Report) and A,B,F Grading (Securities Exchange Commission, Federal Trade Commission, Investors, Shareholders, and Franchisees)
In 2006, Domino’s Pizza’s CEO/chairman David Brandon, created a system “to coerce some franchisees out of the system via contrived or minimal ‘defaults,’ the whistleblower report states. Once defaulted by Domino’s, these franchisees are terminated, but given a ‘deadline to sell’ the terminated location to a Domino’s ‘approved’ purchaser to facilitate the exit of franchise.”
In the April 29, 2008, Quarter 1 Earnings Call, then-CEO Brandon stated that Domino’s had now identified 246 franchisees in the system that represent about 14 percent of stores that are categorized as “F” franchisees. “They are currently failing themselves and our brand and our system . . .” Brandon added, “Suffice to say there will be some ‘shirring’ over the next couple of years as we facilitate changes in ownership of many stores.”
When John Glass, Morgan Stanley, questions Brandon, asking how Domino’s facilitates the transition of F stores to new ownership, and how many F stores are there, Brandon replies, “600 stores are total F’s, the F’s represent, as I recall, 14%.” The CEO said they would look it up to make sure. Regarding the facilitating of the sale, he said the franchise agreement affords the company the ability to have the first right of refusal on the sale of any store, so we’re actively involved in those transaction . . .”
John Glass asks, “Just to clarify, does facilitate mean you buy and resell or are you a broker? Brandon replies that it isn’t their intention to purchase these stores, it is their intention to broker these stores to “A” and “B” franchisees, and any of Domino’s new external franchisee candidates.
In a transcript of CEO J. Patrick Doyle, explaining how stores are rated A, B, F, he tells how Domino’s has a group of 15 to 18 people who are out auditing stores on an ongoing basis. They are in the stores 365 days a year doing unannounced audits, giving stores a grade. Doyle said that’s the first part of grading, but the other is about the franchisees. That’s being done by area leaders in charge of typically 25 to 30 franchisees, about 100 to 120 stores. Those reports go up the ladder to Scott Hinshaw, EVP franchise operations, to approve the list of franchisees who Domino’s feels need to dramatically increase their commitment to the brand or exit the system and sell their stores.
In his transcript, Doyle also addressed how the groundwork for Domino’s success actually began in 2006 when they were completing the process and establishing a single point of sales across their domestic system. That’s when they established an accountability system for their franchisees and started rating them A, B, F. Doyle said that over the course of time, the system went from about 1,300 domestic franchisees to 800 today . He called it “part of the process of cleaning up the system.”
In a lawsuit deposition on April 7, 2014 with a terminated “F” franchisee, Attorney Norman M. Leon, DLA Piper, stated, “If I could just clarify one point, Your Honor? Just briefly. In terms of the grading, we think it’s an irrelevant issue. Franchisees graded an F automatically have been terminated. That’s all the testimony, because they’re always an F.”
Domino’s recruitment of external seasoned franchisees
In replacing terminated “F” franchisees, Chief Financial Officer Michael T. Lawton stated at Morgan Stanley presentation on November 20, 2013, "Our biggest competition for franchisees? We don’t do a lot of recruiting of franchisees from outside of the Domino’s system in the United States. Most of our franchisees started working for other franchisees or within our corporate stores came up through this system and decided that they wanted to invest in the business. So, we really don’t have competitors in it.”
CEO David A. Brandon countered that statement in a Domino’s investor earnings call, 2008 Q1, saying, "We’ve launched an aggressive franchisee recruiting program designed to help us carefully select both internal and external franchise candidates. We’re hosting what we call Discovery Days every month here in Ann Arbor and we plan to create a strong pipeline of franchise candidates to help us replace some of those F’s with candidates who will bring new energy, new investment and new commitment to our brand and system"
In a QSR article on July 1, 2011, NRD Buys Out Florida Domino’s Franchises, Scott Hinshaw, Domino’s Pizza executive vice president of operations and development, acknowledged Aziz Hashim as one of Domino’s external franchisee recruits. He said, “We’re thrilled to have Aziz as part of the Domino’s franchise system. His incredible track record of success, outstanding leadership, and commitment to his diverse portfolio of brands make him the best of the best in the franchising industry.”
CNBC’s article, The franchise king who wants to turn folks into millionaires, published on May 24, 2016, reaffirmed Hashim was welcomed into the Domino’s system as an external multi-brand franchisee. It stated, "From that humble beginning, Aziz Hashim built an 80-unit franchise empire composed of 14 brands — including KFC, Domino's Pizza, Taco Bell, Moe's Southwest Grill, Pizza Hut and Popeye's, as well as PetValu in Canada.”
The whistleblower alleges in his report that Domino’s Pizza performed insider trading on non-public information given to direct competitors and indirect competitors when Domino’s seeks disclosing the non-public information during and after Discovery Days with the full knowledge of the board of directors and the chief executive officer.
In a phone call last month to Chris Brandon, director of Investor relations, he told this reporter that Domino’s is always looking at ways to bring external franchisees into the system. But he quickly added, “But it might be helpful to you to know we are mostly home grown where 90 percent of our franchisees in the U.S. started in our stores, like delivery drivers, pizza makers hourly workers.” He said Discovery Days in recruiting prospective franchisees, internal and external, was not something he was involved in.
When asked about the franchisees in the Domino’s system who operated multiple-brands, Chris Brandon said no, Domino’s does not allow franchisees to own other concepts in the U.S. “Yes, we actually have a policy on that. Internationally, that’s a little more lenient, we have a big master franchisee in India, with different brands. And another in Mexico that also has Starbucks and Burger King, or something.”
SEC offers protections to whistleblowers against retaliation
On its website, SEC stresses that under the Dodd-Frank Wall Street Reform and Consumer Protection Act SEC can now offer more protection to whistleblowers when companies retaliate against them. The Commission Rule 21F-17(a) “prohibits any person from taking any action to prevent you from contacting the SEC directly to report a possible securities law violation.” If a whistleblower feels he/she has been retaliated against because of their report, they may be able to sue the company in court.
Although SEC Whistleblower Program does not admit or deny it is conducting an investigation on a complaint, the whistleblower did receive an acknowledgment of the report submitted.
(Note: Below is a partial list of files that are included in the Whistleblower Report attachments for documentation of the facts in case.)
- ABF Grade Orchestration Exit of Franchisees
- Domino’s Pizza Advertising & Securitization for $1.6 Billion
- Misrepresentation on Distribution & Profit Sharing
- Misrepresentation on Other Businesses
Note: A summary of this report was published on Forbes.com Leadership/Franchise by contributor Janet Sparks on February 15, 2019. Domino's photo above by Sparks.