The Federal Trade Commission announced on October 22, 2008 that it would delay enforcement of the new "Red Flags Rule" until May 1, 2009, from the original November 1, 2008 date. The reason for the delay is to give creditors and financial institutions more time to develop and implement identity theft prevention programs.
The purpose of the Rule is to reduce consumer exposure to identity theft. We believe the Rule is sufficiently broad in scope to cover certain franchise system transactions between a franchisor and its franchisees, and between franchisees and their retail customers. The key element of coverage involves the extension of credit for a covered account. By definition, cash and discrete single credit card payments are not covered by the Rule, nor, generally, are transactions with franchisees and retail customers that are legal entities making payments through corporate accounts. But routine, monthly royalty payment and open account transactions with individual franchisees, common in many franchise systems, could cause the franchise relationship to fall within the scope of the Red Flags Rule. Likewise, franchisee transactions with consumers that allow for payment of the purchase price for goods or services over time under open accounts, even by credit card in pre-authorized installment payments, could cause the franchisee to be covered under the Rule.
How could the Rule apply to a franchise environment? Probably the most common way it could apply is as follows. An individual franchisee with multiple locations routinely orders supplies and some retail inventory from the franchisor's purchasing program on open account, billed and paid by check or Electronic Funds Transfer (EFT) monthly. The store manager responsible for the ordering is selling the inventory and supplies "out the back door," so the franchisee's reports of gross sales reflect inconsistencies with the orders placed by the franchisee's staff for supplies and inventory. In other words, the ratios are outside normal parameters. Under the Red Flags Rule, this fairly common scenario means that the franchisor should identify this circumstance and notify the franchisee that unusual activity is occurring in the account. Since much of this activity is automated, the connection between wholesale and retail sales levels should be programmed and calculated to produce a "red flag."