The ABCs on NASAA’s Proposed Changes to Financial Performance Representations

On October 1, 2015, the North American Securities Administrators Association (“NASAA”) ‎published 19 proposed Questions and Answers addressing the preparation of financial ‎performance representations (“FPRs”). This proposed “Commentary,” discussed in this article, would likely affect most franchisors that make FPRs in their franchise disclosure documents. Franchisors, franchisees, and other interested parties have until November 2, 2015 to submit ‎comments to NASAA on the proposed Commentary. If no comments are received, the ‎Commentary will likely become law, as written, in 2016.‎

Some portions of the Commentary will be welcome clarifications that should reduce the ‎number of inconsistent comments franchisors receive from state regulators who review their ‎franchise filings. Others will impose burdensome requirements. We urge you to read the ‎Commentary carefully, and consider commenting on provisions you believe will be problematic ‎for your system. The task force that prepared the Commentary will review every comment ‎received. To the extent you can show that a proposed change will not be of significant benefit to ‎franchisees, or that the cost of complying outweighs the benefits to prospective franchisees, or ‎that a proposed change will likely cause many established franchisors to stop making FPRs, your ‎comments will receive more significant consideration.

Section A of the proposed Commentary is merely a recitation of previously issued ‎questions and answers. They were reprinted by NASAA for information only, and comments on ‎those items will not be considered.‎

Section B deals with the use of financial information from company-owned outlets, as ‎opposed to franchisee-owned outlets. This section makes clear that company-owned information ‎can be used, but it will require disclosure of franchisee information when a franchisor making an ‎FPR has at least 10 franchisees, and prohibit start-up franchisors from providing more than gross ‎sales information to prospective franchisees.

Section C addresses the use of subsets. For nearly the last decade, franchisors have been ‎able to prepare FPRs based not necessarily on all of their units, but on subsets, such as those in ‎existence for more than one year, or those located in specific geographic markets. This section of ‎the Commentary gives franchisors more direction on preparing these FPRs. It also provides that ‎a subset consisting of only the best performing outlets is not an appropriate subset, unless ‎information is also disclosed for the corresponding units at the low end of the spectrum.‎

Section D deals with the use of averages and outliers. Q and A 19.15 requires that ‎whenever an average is given, the median must also be disclosed in order to avoid having a ‎number of very strong locations present a misleading picture as to where the more typical units ‎might fall. Q and A 19.16 requires franchisors that disclose information only for units that have ‎been open for at least one full year, a common subset, to disclose the number of units that closed ‎within their first year of operation for each year covered in the FPR. Q and A 19.7 prohibits ‎presentation of a subset consisting of only high-grossing outlets that are not representative of the ‎other outlets in the system.

Section E covers forecasts and projections. It makes clear that projections must be based ‎on historical data from the brand offered and not on hypotheticals or results in other systems.

Finally, Section F addresses disclaimers. It clarifies the one disclaimer that can be used, ‎and the manner in which it must appear. This portion of the Commentary should help franchisors ‎avoid problems they have had in the past with states imposing different requirements as to the ‎manner in which the mandated disclaimer appears.‎

We will be addressing with our clients how the Commentary will affect the FPRs they ‎have in their current Item 19 disclosures. Other franchisors should immediately seek counsel to ‎review the Commentary and their current Item 19, so that they can have input on the ‎Commentary. Indeed, if you wait for the Commentary to become final, you may be forced to ‎make changes to your FPRs that will render them less useful to prospective franchisees, or you ‎may find that you cannot even prepare a meaningful FPR that complies with the new ‎requirements.‎

Click here for the Commentary.