Wall Street Seeks To Learn From and Influence FTC Rulemaking

I am amazed by a front-business page New York Times story - Why Short Sellers Want to Crash The Tupperware Party -- reporting that investors are short selling positions in companies such as Avon Products, Herbalife, and Pre-Paid Legal because of pending Federal Trade Commission rulemaking on business opportunity programs. Wall Street is not only seeking to read tea leaves, but some investors are going so far as to try to influence the promulgation of the regulation in order to advance the value of their short positions.

As I have previously written in DM News "Biz Ops Headed For Tough New Rules", the FTC has proposed a regulation that would require onerous obligations for the sale of all business opportunity programs. The proposed rulemaking is a continuation of a proceeding that began nearly a decade ago, in 1997. While the proposed rule took a decade to be drafted, it does appear that it will take affect in our lifetime, although clearly not before the end of the year.

As proposed, the rule would stifle business arrangements where a seller solicits a purchaser to enter into a new business in which there is either an earnings claim or a representation that the purchaser will be provided with business assistance by requiring the seller to make all sorts of disclosures at least 7 days in advance of the contract or payment. The seller must include in these disclosures all legal actions he or she has faced in the past 10 years involving either the seller or any prior business of the seller or its management or any salespeople involving fraud, deceptive acts or practices, or securities law violations. The rule would require disclosure of not just the cancellation and refund policy, but the number of oral and written cancellation requests received in the past two years. The rule also would require the seller to provide the buyer with a list of at least 10 customers in nearby areas who purchased, or disclosure of all customers within the past three years. Moreover, earnings claims have an entire section in the proposed rule. Not only must a seller possess adequate substantiation for an earnings claim (which has always been required), but the seller must state in immediate conjunction with an advertised claim the beginning and end dates in which the represented earnings were made, the number and percentage of purchasers during that time who achieved the represented earnings and provide a written earning statement along with the mandatory disclosure statement.

Comments to the proposed rule were to be submitted by September 29, 2006 and apparently over 15,000 were submitted. The Times reports that certain investors have recognized the overwhelming impact the regulations (if enacted as proposed) will have on direct sales businesses and have been those stocks short - i.e., expecting that there price will decline. If the regulations take effect as proposed and in short order, this may prove to be a well-though out investment decision. However, if the regulations continue to go through its snail pace or if the FTC revises the regulations to take into account the numerous objections, the gamble may backfire on the short sellers. This type of investment behavior and analysis is certainly permissible and, while companies may disdain its effect, it is a reality of the investment marketplace.

What is, however, behavior well over the line, is the report that certain short sellers - in one instance through an attorney - have submitted comments to the FTC urging the adoption of the proposed regulations with unsupported and unexplained statements hailing the proposed regulations. While regulatory comments are an integral part of rulemaking proceedings, it is a shame that some people will seek to abuse this important right that Americans have in order to advance a stock position. This abuse of the process should not be respected by the regulatory authorities.

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