United States Oil Fund, L.P. ("USO") is an exchange-traded fund that issues limited partnership shares traded on the NYSE Arca (the "Shares"). USO is also a commodity pool operator regulated by the Commodity Futures Trading Commission. According to USO's registration statement filed with the Securities and Exchange Commission ("SEC"), USO's investment objective is for the net asset value ("NAV") of the Shares to reflect the daily changes, in percentage terms, of the NYMEX West Texas Intermediate Crude Oil Futures Contract that is the near-month contract to expire (the "Benchmark Oil Futures Contract"), subject to certain exceptions.
In March and April 2020, with oil futures contracts settling below zero, investors were pouring into USO. On April 20, 2020, USO announced, in a Form 8-K, that it anticipated exhausting its inventory of Shares and the next day filed another Form 8-K confirming that it was suspending issuances of Shares. On April 21, 2020, USO filed a registration statement on Form S-3 with the SEC to register more Shares.
At about the same time as when USO made its announcements and also filed the Form S-3, its sole futures commission merchant (the "FCM") told USO, on April 22, 2020, and confirmed the next day, that FCM would henceforth limit USO's ability to invest through the FCM the proceeds of future Share creations. Consequently, USO would be forced to use the proceeds from future Share creations to purchase U.S. Treasuries or to hold cash, rather than investing in oil futures contracts. Investing in oil futures contracts was USO's stated investment objective. Investing in U.S. Treasuries or cash would cause a risk of tracking error between USO's investment objective (tracking the changes in the spot price of crude oil) and its NAV when the new Shares were available for offer and sale.
Without disclosing the FCM limit and in response thereto, USO filed Forms 8-K between April 24 and April 30, 2020, describing a change in USO's investments from its stated investment objective to diversified investments ranging from front-month futures contracts to further-down-the-curve futures contracts, and ending with investments-in-oil futures contracts other than the Benchmark Oil Futures Contract.
Following the imposition of the FCM limit, USO filed several pre-effective amendments to its Form S-3. None of these amendments fully disclosed the character and nature of the FCM limit. During the review by the SEC Staff of these amendments, USO did not inform the Staff of the FCM's limitation. The FCM asked USO whether the SEC Staff had been informed of the FCM limit, to which USO gave a non-responsive answer. Ultimately, the FCM contacted the Staff and told them of the nature of the limitation. The Staff, in a comment letter dated May 13, 2020, asked USO to disclose the constraints put on USO by the FCM. In a pre-effective amendment dated May 21, 2020, USO disclosed the FCM's limitation. USO filed Forms 8-K on May 29 and June 9, 2020 announcing agreements with additional futures commission merchants allowing USO to invest the proceeds from sales of new Shares in oil futures contracts. On June 12, 2020, the registration statement was declared effective and a prospectus was filed offering new Shares.
In a Cease and Desist Order dated November 8, 2021 (the "Order"), the SEC stated that "[b]y failing to adequately inform the investing public, during the period from April 24 through May 21, 2020, of the specific constraints put on [USO] and, in turn, the impact that those constraints would have on [USO's] ability to meet its investment objective, each of the above public filings [was] materially misleading."1 The "above public filings" were the Forms 8-K and the pre-effective amendments to the registration statement filed between April 24, 2020 and May 21, 2020, except the final pre-effective amendment dated May 21, 2020, in which corrective disclosure was included about the FCM limit and a related risk factor.
The Order states that "[a]s a result of the conduct described above, USO ... violated Section 17(a)(3) of the Securities Act, which prohibits the offer or sale of securities, engaging in any transaction, practice or course of business which operates or would operate as a fraud or deceit upon the purchaser."2
Analysis
At first blush, this would seem like an opportunity for the SEC to call down fire upon USO. We have an issuer that did not fully disclose information material to investors in multiple public filings, even when the FCM prompted USO to tell the Staff as part of their review of the registration statement. The Order notes that USO was experiencing record daily inflows of retail investors while oil futures contracts were settling in negative territory.3 Yet the Order does not allege any financial harm to these investors.
What is missing from this story are offers and sales. During the time that USO was making misleading filings, it had no Shares to sell. Many of the alleged misstatements were in pre-effective amendments to the registration statement, under which no Shares were offered or sold until the disclosure was corrected and the registration statement declared effective. Without offer and sales, there is no liability under Sections 11 or 12 of the Securities Act, nor under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. That leaves the catchall negligence liability of Section 17 of the Securities Act, even though there is no purchaser who suffered fraud or deceit.
Perhaps the reason that the SEC could not find any investors alleging financial harm was the timing of the events. The reason that there were record inflows of investors into USO was that oil prices were bottoming out at historical lows. On the day that USO announced it had no new inventory to sell, the Shares closed at $33.68. The next day, when USO filed the registration statement with the SEC, the Shares closed at $30.00. They dropped to as low as $16.88 on April 28, 2020, closed at $26.43 on June 12, 2020, the day that the registration statement was declared effective, and, in the period from December 10, 2020 to December 10, 2021, ranged from $31.37 to $58.69. Investors in USO made, not lost, money during the time period covered by the Order.
Footnotes
1 The Order is available at: United States Commodity Funds LLC and United States Oil Fund, LP (sec.gov).
2 Order at p. 8. "Negligence is sufficient to establish a violation of Section 17(a)(3) of the Securities Act." Order at n.4 (citation omitted).
3 See the Order at 2.
Originally published in REVERSEinquiries: Volume 4, Issue
6.
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