» Franchise Fraud

Franchise Fraud

This particular type of fraud is also often referred to as a chain referral scheme or pyramid scheme. To begin with, the potential franchisee is offered a franchise (distributorship) to market a particular product. However, the money is mainly earned by selling distributorships, and not the product. The whole scheme collapses when the person selling franchises runs out of potential investors.

Franchising is regulated in the U.S. by a convoluted system of franchise rules and regulations featuring industry guidelines, state laws and the Federal Trade Commission Franchise rule. Its most recent re-writing was in 2007, FR 2007a, pp 15544-15575. FR 200a lays out what information a franchisor must reveal to a prospective franchisee. Whether the disclosure document and the other rules laid out by law are followed is another question entirely.

Generally, in this kind of fraud, franchisors try to pressure a buyer who leaves their system to sign what amounts to a gag order, which in essence forbids the person leaving the business to talk to anyone about their experiences. This makes misrepresentation possible to other prospective franchisees that are not told the real story about the system, which affects their decision to buy or not to buy into the system. Current rules relating to selling franchises assign no obligation to disclose negative information about the performance of the system.