NASAA Adopts New Rules on Financial Performance Representations

On May 8, 2017, the North American Securities Administrators Association, Inc. (“NASAA”) formally issued new guidance, the NASAA FPR Commentary (the “Commentary”), to clarify what constitutes a reasonable basis in making a financial performance representation (“FPR”)—with specific guidance for a variety of common FPRs that are made in Item 19 of Franchise Disclosure Documents (“FDDs”).  Click here to see the full text of the Commentary.   The Commentary provides welcome guidance to franchisors that have been reluctant to include FPRs in their FDDs, or whose efforts to include FPRs have been rebuffed by state franchise examiners, but it will ultimately require all franchisors that currently include an FPR in their FDD to revise their FPR.

Summary of the Commentary
A prospective franchisee’s first question to a franchisor when researching the purchase of a franchise is often: How much money can I make?  However, under federal and state franchise disclosure laws, franchisors are restricted in how they answer that question.  With very limited exceptions, current federal and state laws permit a franchisor to provide financial information to prospective franchisees only by making an FPR in Item 19 of their FDD, and then only when the franchisor has a “reasonable basis” for making the claim and substantiation for the representation.  

The Commentary provides clarity on what constitutes a reasonable basis for making an FPR.  It clarifies that company-owned results can be used in making an FPR but details the information that must accompany the disclosure of those results.  A franchisor can continue to use subsets of outlets that share a particular set of characteristics, but the subset selected cannot be misleading.  For example, if a subset is based only on the highest grossing 10% of outlets, the lowest grossing 10% of outlets must also be included.  Data from outlets that closed during the time period shown in the FPR may be excluded provided certain new disclosures are included concerning the number of outlets that closed during the period(s).  Whenever “average” data is included in an FPR, “median” data must also be included, and vice versa.  These guidelines, and others in the Commentary, should assist franchisors in making more accurate FPRs. 

Next Steps
The Commentary will not be effective until November 8, 2017.  Thus, it will not apply to new franchisors that register between now and the first week of November 2017.  However, since these franchisors will have to comply with the Commentary when they renew, we recommend these franchisors comply with the Commentary now so they do not have to rewrite their Item 19’s when they renew.  Franchisors with fiscal years ending at the end of November and December, most of whom recently renewed their franchise registrations, will not have to comply with the Commentary until their next renewal and there is no requirement to do so before then unless they are otherwise amending their Item 19 in which case we would recommend they update their Item 19 to comply with the Commentary.  (An amendment of another section of the FDD will not trigger an amendment for Item 19.)  Franchisors will fiscal year ends in other months will not have to comply with the new Commentary until their first renewal after the November 8, 2017 date that the Commentary becomes effective, but once again, to avoid extra work, we recommend they comply when they next renew their registrations. 

We have been aware of the deliberations over the Commentary for the last four years as Chuck Modell served on the task force that advised NASAA with respect to the Commentary.  We believe the adoption of the Commentary is beneficial for our franchisor clients who seek to include financial performance information in their FDDs.  We will be consulting with them concerning the information they need to track to comply with the Commentary.  Other franchisors should contact their attorneys to discuss the Commentary and the changes required to their Item 19’s, or whether to include an FPR if they do not already include it in their FDD.