March 2007 - Legal Perspective

Business Opportunity Rule: A Grave Threat

By Gary D. Hailey

Regular readers of Electronic Retailer magazine may not be aware that the Federal Trade Commission’s (FTC) proposed “Business Opportunity Rule” poses a grave threat to the direct sales industry. If this proposal becomes law, those who are subject to it will have to disclose their customers’ names and telephone numbers, details about legal actions brought against the seller (even if the seller eventually won in court), the number of cancellation or refund requests received (whether justified or not) and other information. In addition, they will have to provide those disclosures at least seven days before signing a contract or accepting payment from prospective buyers.

It’s not much of an exaggeration to say that the author of a cookbook (or teacher of a cooking class) might be subject to the proposed rule because his or her readers (or students) could use what they learn to open a new restaurant or start a catering business. So, if you sell publications or offer educational or coaching services, you should be very afraid of this FTC proposal.

Let’s take a quick look at the proposed rule’s definition of “business opportunity,” which has three parts. First, the seller must solicit the prospective purchaser to enter into a new business. Second, the seller must receive some kind of payment. Third, there must be either (1) an “earnings claim” (a simple earnings testimonial from a satisfied customer is enough); or (2) an offer to provide “business assistance,” which is defined as “advice, information or support…in connection with the establishment or operation of a new business,” including the “advising or training…[of] the purchaser in the promotion, operation or management of a new business.”

To illustrate how this definition applies to the sale of publications, let’s consider a widely available book called How to Earn Up to $100,000 a Year or More from Home by Mail: The Complete Guide to Starting Your Own Home-Based Mail Order Business, by Terrence Thomas. Virtually any attempt to sell such a book-even an ad that simply mentions the book’s title-could be characterized as a solicitation to enter into a new business. And the very title of the book contains an earnings claim (“earn up to $100,000 a year or more”) and promises to provide advice and information in connection with the establishment or operation of a new business (“the complete guide to starting your own home-based mail order business”).

I’m confident that the FTC staff would never bring a rule enforcement action against the author or publisher of this book, or a bookstore that advertises and sells it. Such an action would be inconsistent with the First Amendment and FTC enforcement policy. But the fact that the proposed rule could be interpreted to support such an action is proof that its definition of business opportunity is far too expansive.

Let’s look at some examples of educational courses that could be covered by the proposed rule. For example, the Cambridge Center for Adult Education-a non-profit organization that was incorporated in 1876 and is currently supported by grants from many well-known foundations and businesses in Cambridge, Mass.-recently advertised a one-day course called “Starting Your Own Import Business.” The CCAE’s online course catalog describes the course as follows: “This exciting seminar will introduce you to the lucrative business of importing….Discover how to locate overseas supplies, how to pay foreign suppliers without financial risk, and how to set up international transportation, documentation and U.S. Customs regulations. You’ll also learn about thousands of various products from around the world, many of which are not currently on the U.S. market. This course has been designed for first-time importers with no experience.”

Northern Virginia Community College-a large community college that annually enrolls thousands of students from the Washington, D.C., suburbs-offers courses ranging from “Successful Real Estate Investing” (“Create wealth by investing in real estate, just as most self-made millionaires do. This course will show you the fundamentals of safe and successful real estate investing. Topics covered will include how to locate good buys, negotiate with sellers, creative financing, working deals with investors and much more”) to “Learn to Buy and Sell on eBay” to “Publish It Yourself: How to Start and Operate Your Own Publishing Business” (“Convert manuscripts into extra income by starting your own publishing company. Avoid common pitfalls that can slow the growth of your publishing enterprise. Learn how to format your works in a way that will save you hundreds of dollars. Find out everything you need to know to profit from your own publishing company”).

All these courses solicit prospective purchasers to enter into a new business. It’s not clear whether some of the statements relating to the income that can be earned from such businesses are specific enough to meet the definition of an “earnings claim,” but it seems clear that all of these descriptions offer “business assistance,” as that term is defined by the proposed rule. Some of the particular sellers in the examples above may not be subject to the Commission’s jurisdiction because they are non-profit entities or state agencies.

But many for-profit sellers who clearly are subject to the Commission’s jurisdiction solicit prospective purchasers to enter into the very same kinds of new businesses and offer the very same kinds of business assistance. And based on past FTC enforcement actions, it seems much more likely than not that the Commission would take the position that the proposed rule applies to those who present live business opportunity seminars, or offer consulting or coaching services to those starting businesses of their own.

As noted above, enforcement of the proposed rule in cases involving the promotion and sale of publications that present money-making techniques usually would be inconsistent with the First Amendment and the FTC’s “mirror image doctrine.” That’s an FTC enforcement policy statement that says the agency usually will not challenge advertising that describes the contents of a book even if it believes that statements in the book are false and unsubstantiated-because that would be a back-door way for the government to regulate the content of books, which would obviously violate the First Amendment.

In the past, the FTC staff has taken a very narrow view of the mirror image doctrine and attempted to limit its application strictly to publications. This has led to strange results, at least on occasion. For example, in an investigation involving one of my clients, the staff took the position that the promotion and sale of videotapes of educational seminars or lectures that had been presented originally to a live audience were covered by the mirror image doctrine. After all, tapes (like books) are publications. But the staff argued that the advertising and sale of admission to those very same live seminars was not covered by the mirror image doctrine.

This kind of hypertechnical analysis worships form and ignores substance. The issue should not be the medium in which the message is presented. What is being sold here is “advice” or “information” to use the language of the proposed rule-and the Commission should not be regulating the sale of information regardless of what kind of subject matter is involved.

This past summer, I made this same argument in written comments to the FTC. While those comments focus on why any final FTC rule should exempt sellers of business opportunity education and information services, I also made a number of other arguments: First, if you present a truthful earnings testimonial from a customer, the proposed rule requires burdensome earnings disclosures. This provision is inconsistent with FTC testimonial guidelines. When accompanied by an appropriate “Results not typical” disclosure, a truthful earnings testimonial is not deceptive and should not trigger the earnings disclosure provision of the proposed rule. In many cases, sellers of educational and informational products and services would simply not possess the detailed customer earnings information they would be required to disclose. (This issue is even more significant given recent indications that the FTC wants to tighten up its Testimonial and Endorsement Guides.)

Second, the requirement that sellers provide a disclosure document to prospective buyers seven days before accepting payment for educational and informational products and services would harm consumers as well as sellers by delaying the fulfillment of orders for business opportunity publications and requiring those who offer in-person educational courses or workshops to cut off enrollment well in advance of the event.

Third, the proposed rule would require the disclosure of information about certain prior legal actions involving the seller, its affiliates and its officers, directors, sales managers, or sales personnel-whether or not the purchaser had any contact with that individual, and whether or not that individual eventually prevailed in that legal action. The rationale for this proposed requirement is that the mere filing of certain legal actions against a seller is material to prospective purchasers.

But given the current state of affairs in the American legal system, this proposal is completely misguided. The threshold for filing such lawsuits is very minimal, and the proposed prohibition on including explanatory information concerning such legal actions will make it likely that many consumers will be misled more than enlightened by such a disclosure. And if the filing of legal actions alleging fraud or misrepresentation is material to purchasers of business opportunities, why isn’t it equally material to purchasers of new or used cars, home repair and improvement services, and numerous other big-ticket items? (The sellers of these goods and services are not required to make such disclosures.)

Fourth, the proposed requirement that all written and oral cancellation and refund requests be disclosed would have a perverse effect. Sellers with liberal free-trial periods and refund policies who took pains to be responsive to consumer returns and refund requests might attract a large number of very casual purchasers who decided not to finalize purchases-and the result would be an apparently large number of dissatisfied customers that could mislead prospective purchasers. (New car dealers sometimes give consumers who come in for a test drive cash, gift certificates, tickets to sporting events, or other items of value. Not surprisingly, such offers will attract a certain number of people who have no intention of buying a new car, or at most a very casual interest in doing so. It would be a mistake to say that the dealer’s cars were poor in quality or overpriced just because few of those consumers decided to purchase one after taking the test drive.)

By contrast, sellers who short-staffed their customer service telephones might appear to have low refund-request rates because they made it difficult for purchasers to get through to take advantage of a money-back guarantee. And what about refund requests that come in after the expiration of a money-back guarantee or free-trial period? Is the seller supposed to track and disclose even invalid refund demands?

Finally, requiring disclosure of a seller’s customer names and telephone numbers to prospective purchasers is a bad idea. This proposed provision is essentially a requirement that a seller share some or all of its customer list-one of its most valuable trade secrets-with anyone who asks for it, including competitors. But what is truly surprising about this proposal is the FTC’s utter disregard for the privacy of these customers. The FTC has gone to great lengths to protect consumers from both large and not-so-large threats to their privacy. It blithely dismisses such concerns here, failing to even provide for an opt-out mechanism for customers who don’t want their information shared.

Another flaw in this proposal is that a prospective purchaser will have no guarantee that the information he or she gets from other purchasers is accurate. For example, the proposed rule would require that the seller disclose the names of past purchasers who live closest to the prospective purchaser. It hardly would be surprising if those who had purchased a business opportunity in the past attempted to discourage competition from future purchasers by painting a negative picture of their experience with the seller.

Gary D. Hailey is a partner in the Washington, D.C., office of Venable LLP. He can be reached at (202) 344-4997, or via e-mail at ghai
[email protected]


No Comments

No comments yet.

RSS feed for comments on this post. TrackBack URI

Leave a comment