'USO' Facing Regulatory Action

August 19, 2020

The United States Oil Fund LP (USO), the world's largest oil ETF, is facing charges of fraud from the Securities and Exchange Commission (SEC) over disclosures made regarding several significant portfolio changes enacted during this spring's sell-off in crude oil prices.

On Aug. 17, the SEC sent a Wells notice to USO, its issuer and investment advisor US Commodity Funds, and the company's CEO, John Love. A Wells notice is a letter sent by a securities regulatory agency informing the recipients of impending charges.

In the notice, SEC staff indicated they'd made the preliminary determination to recommend enforcement action.

USO's managers deny any wrongdoing, however.

"USCF, USO, and Mr. Love maintain that USO’s disclosures and their actions were appropriate," according to USCF's latest SEC filing announcing receipt of the letter. "They intend to vigorously contest the allegations made by the SEC staff in the Wells Notice and expect to engage in a dialogue with the SEC staff regarding this matter."

USO Shook Up Portfolio Structure

The Wells notice is the latest plot twist in USO's wild tale, which began when crude oil prices plunged in late April. On April 20, near-month WTI crude oil futures struck a record low of -$37.63/barrel. (Read: "Stunningly, Oil Prices Crash Below Zero")

With $4.2 billion in assets under management, USO is the largest crude oil ETF in the world. Until a few months ago, its investment methodology was fairly simple: The fund held only front-month crude oil futures contracts, rolling into the next nearest-month contract two weeks from expiration. (Read: "How Oil ETFs Work")

However, in late April and early May, USO's managers implemented a number of rapid-fire portfolio changes that broadened USO's exposure across the futures curve. (Read: "Biggest Oil ETF Shakes Up Structure")

The changes were designed to address two concerns: 1) mitigating losses during the historic plunge in crude prices; and 2)  avoiding exceeding CFTC position limits on individual futures contracts, even as speculative investors plowed billions of new net money into the fund hoping to play a rebound in oil.

Within the span of six weeks, USCF issued six disclosures of portfolio changes. By the end of it, USO had ended up effectively actively managed, with managers allowing themselves the discretion to invest in any futures contract "in any month available or in varying percentages," or in noncrude oil futures investments, "without further disclosure" to investors. (Read: "More Big Changes For Biggest Oil ETF")

Did USO Engage In Securities Fraud?

It's those disclosures that concern the SEC now. The Wells notice, which is neither a formal charge nor a determination that any laws were broken, alleges violations of Sections 17(a)(1) and 17(a)(3) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 194, and Rule 10b-5.

In plain English, those are the sections of securities law dealing with fraud.

Section 17(a) makes it a crime to "employ any device, scheme or artifice to defraud" or "engage in any transaction, practice or course of business which operates or would operate as a fraud or deceit upon the purchaser" when buying or selling securities, including securitylike swaps.

Section 10(b) is more of the same, making it a crime to use "any manipulative or deceptive device" in connection with the purchase or sale of securities registered on an exchange.

Rule 10b-5, which is best known as the rule cited in cases of insider trading, makes illegal any attempt to defraud, omit or make untrue statements about material facts, or otherwise engage in fraud or deceit of investors when buying and selling stocks.

Now, USO, USCF and Love have the chance to submit a written statement in their defense.

This isn't the first legal action USO has faced. In June, several law firms, including Rosen Law Firm, Johnson Fistel LLP and Robbins Geller Rudman & Dowd LLP, filed class action lawsuits against USO, claiming the fund failed to disclose the known market impacts and risks of its new investment strategy. These cases are still in the earliest stages and have yet to proceed to trial.

Contact Lara Crigger at [email protected]

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