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Why Franchise Organizations Need Corporate Compliance Programs

As the world becomes more regulatory-minded, legal issues facing franchise systems have become more complex and far reaching.

A recent headline read: “Federal authorities seized 14 7-Eleven stores in New York and Virginia, and indicted nine owners and managers, charging them with stealing identities and exploiting more than 50 undocumented immigrants.” Such publicity does not build reputational goodwill within a franchise system. Whether the allegation has merit or not, any franchise system having to face this type of claim will find it, at minimum, despoiling of its reputation and disruptive of its operations.

Franchising has undergone titanic shifts over the past decades. Once the purveyors of single products or services, today’s franchise systems have morphed into mega- distribution networks offering goods and services through multiple channels on a global basis. As the world becomes more regulatory-minded, legal issues facing franchise systems have become more complex and far reaching.

In a different age, a franchise system was unlikely to face regulations implicating privacy rights, foreign corrupt practices, money laundering, health care, environmental violations or immigration practices. The multitude of laws that touch franchising read like a dictionary of acronyms (ACA, FCPA, ADA and so on). Franchise organizations must learn to navigate the requirements of the following, just to name a few.

  • The Affordable Care Act
  • Foreign Corrupt Practices Act
  • Americans With Disabilities Act
  • Money Laundering Control Act
  • Federal Trade Commission Act
  • Immigration and Nationality Act
  • The Comprehensive Environmental Response, Compensation and Liability Act

A franchise system that violates any of these laws can find itself facing monetary damages, fines, restitution, corporate monitoring and even criminal sanctions.

Franchise systems have little idea how close to the regulatory line they come in doing what they believe to be helpful to the growth and success of their businesses.

Ignorance of the law is no defense to non-compliance. And, in addition to civil sanctions, franchisors can find themselves in the cross hairs of a criminal investigation of its franchisees, as with the 7-Eleven investigation. Consequences are serious, even if the prosecution does not put the organization out of business. In addition to fines and restitution, an organization may be required to submit its operations to a court or government monitoring program or enter into a deferred prosecution agreement. This may require the organization to publicize the results of the investigation in its corporate material. In the franchise context this would mean its franchise disclosure document, as well as in training seminars for its franchisees. However the monitoring program or other sanctions are framed, it can burden continuing operations. As such, it behooves both franchisor and the franchisee to develop and implement compliance programs to educate their employees as to responsible and lawful conduct.

Use of Sentencing Guidelines to Frame Compliance Program

Ted P. Pearce is special counsel at the law firm of Nexsen Pruet in the Charlotte, N.C.

Ted P. Pearce is special counsel at the law firm of Nexsen Pruet in the Charlotte, N.C.

Equally as important as developing a responsible corporate culture, corporate compliance programs can mitigate consequences of unlawful organizational behavior for purposes of establishing the required punishment strictures under the Federal Sentencing Organizational Guidelines. In 1984, Congress created the U.S. Sentencing Commission in response to a perception that there was an unfair disparity in the jail sentences imposed on individuals across the federal system. The original guidelines for individuals were enacted in 1987. In 1991, the guidelines were broadened to include organizations, and to include compliance programs as a mitigating factor to punishment. The guidelines were further amended in 2010 to provide additional guidance on the type of remedial efforts that an organization would need to undertake to receive credit for its corporate compliance and ethics programs.

The guidelines should be of special interest to franchise organizations because they both spell out how a company can soften the consequences of criminal conduct and set forth what the government considers to be an effective compliance and ethics program to avoid criminal conduct altogether. Moreover, although the guidelines are focused on criminal regulation, a franchise system that follows the guidelines’ government roadmap in implementing a corporate compliance program will naturally implement practices that reduce the likelihood of civil violations.

The Impact of Effective Compliance

Ted P. Pearce is special counsel and William R. Terpening is a partner at the law firm of Nexsen Pruet in the Charlotte, N.C.

Ted P. Pearce is special counsel and William R. Terpening is a partner at the law firm of Nexsen Pruet in the Charlotte, N.C.

The guidelines provide a good roadmap for organizations on how to organize and implement an effective compliance program to blunt exposure to both criminal and civil prosecutions. An effective compliance and ethics program must satisfy the following seven specific minimum requirements:

  1. “The organization must establish compliance standards and procedures.” A company must canvass its potential illegal conduct, make an inventory of compliance directives already in existence, determine whether these directives are adequate and issue new directives as necessary. The company should keep some record to show the particular risks that it considered and evaluated.
  2. Specific high-level managers must have “overall responsibility” for compliance. The compliance program should be broken down to different areas giving responsibility of each area to a different high-level manager. The job description of each of these managers should include the manager’s responsibility for compliance in each area of potential illegal conduct.
  3. The company should take “care not to delegate substantial discretionary authority to individuals” with a “propensity to engage in illegal activities.”
  4. The standards must be communicated effectively by training programs or publications. A paper program, while necessary, is not sufficient. Regular programs should be established with employees relative to their responsibilities. For example, employees who will deal in environmental matters should be regularly trained in the identification and reporting of violations of any environmental acts that affect the corporation’s business.
  5. The company must have (a) “monitoring and auditing systems reasonably designed to detect illegal conduct” and (b) a publicized “reporting system” that will enable employees to report offenses by others “without fear of retribution.” The idea of explicit procedures regarding “whistle blowers” may be new for some companies. There is nothing worse than an employee who is afraid to report concerns about possible illegal activities to management, so that they can first be investigated internally.
  6. Standards must be enforced by “appropriate disciplinary mechanisms, including, as appropriate, discipline of individuals responsible for the failure to detect an offense.” Corporations must extend the same leniency to their employees who report themselves as they hope prosecutors will extend to corporations which report themselves.
  7. The program should be modified after detection of an offense. A company should learn from its prior history. The effectiveness of the compliance program ultimately will be judged by the lack of recurring misconduct.

Franchise systems face daily business risks. Beyond evaluating everyday risk factors, an organization can better manage that risk with a comprehensive and well-maintained corporate compliance program. To operate without one is to play Blind Man’s Bluff. n

Ted P. Pearce is special counsel and William R. Terpening is a partner at the law firm of Nexsen Pruet in the Charlotte, N.C. Find them at fransocial.franchise.org via the directory.

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